We have all turned into Fed watchers. The markets are clearly focused on when the Federal Reserve will increase short-term interest rates: by how much and how often. While it would clearly like to normalize interest rates after being near zero since December 2008, the Fed has repeatedly said that any change in policy will be data dependent (when is it not?). Since the markets anticipate that a modification in monetary policy will affect investment returns, let’s take a look at the data.
Industrial production declined in April for the fifth straight month. The Fed reported that it was down 0.3% from March. Retail sales have been weak, too. First quarter numbers, much like last year, were attributed by some to severe winter weather. April’s warmer weather didn’t seem to improve consumers’ propensity to spend. The mystery is that retail sales did not respond favorably to the lower gas prices that came with the precipitous fall in energy prices. Perhaps consumers did not believe that the decline in energy prices would last, and, in fact, energy prices have started to move back up. Or with deflationary forces in play, could savings be increasingly important? Despite fairly robust consumer sentiment numbers from the University of Michigan, their preliminary estimate for May came in at 88.6, a decline in the index of 7.3 from April.
Yet, the early April Nonfarm Payroll Employment number was better than consensus estimates and came in at 223,000. This was indeed encouraging news in light of March’s bleak 85,000, which will hopefully be revised upward. US Initial Jobless Claims came in last week at 274,000, a reassuring number that employment conditions were improving. The Bureau of Labor Statistics also reported that unemployment remained at 5.4%. The April CPI and Real Wage Report reflect a normalization of the economy. Although the Headline CPI rose only 0.1% (-0.2% Y/Y), the Core CPI ex- Energy and Food went up 0.3% in April and 1.8% Y/Y.
Our view is that as much as the Fed would like to raise interest rates above zero, it will be cautious as it balances a generally weak economy with a modestly improving labor market and benign inflation numbers. A dovish Fed will want to avoid a “1937 scenario” when the Federal Reserve increased interest rates and threw an economy in a depression into a recession. A rate hike in June is unlikely, and later rate increases will be subdued.
In a slow economy with interest rates remaining “lower for longer” where to invest? Interest sensitive areas, such as real estate, utilities and home construction should benefit as well as selected sectors where growth prevails. Despite a weak economy with potentially disappointing earnings, a cautious Fed may support equity prices.
John Hess 
Falgun Jariwala 
Managing Principal Managing Director
jhess@nsinvestors.com fjariwala@nsinvestors.com
www.nsinvestors.com www.nsinvestors.com
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1. Data available on U.S. Census Bureau website:https://www.census.gov/construction/nrs/new_vs_existing.html