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The Odds Against Higher Interest Rates

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Thursday, October 29, 2015
Money and Markets
YOUR BEST SOURCE FOR THE UNBIASED MARKET COMMENTARY YOU WON'T GET FROM WALL STREET
The Odds Against Higher Interest Rates
by Mike Burnick

Dear ,

This week's Federal Reserve policy meeting was yet another nonevent as expected. In fact, recent economic data has taken a definite turn for the worse including:

A surprisingly weak September jobs report, including downward revisions to job growth in previous months ...

Dismal manufacturing data that has spread to every region of the U.S. ...

And this week's shockingly bad report on new home sales, which plunged 15% month-over-month to the lowest level in almost a year.

The downbeat economic data is pushing the likelihood of a Fed interest rate increase further and further into the future. In fact, if you take a closer look at the market's own assessment about the likely path for the Fed funds rate, you'll see that nobody expects the Fed to raise rates anytime soon.

Just take a look at the chart below and you'll see what I mean.


Click image for larger view

The probability of the Fed hiking rates in October plunged from a 45% chance just four months ago, to just a 4% chance as the Fed met this week!

And the odds of a rate increase by March 2016 are barely more than 50/50 at this point, down from a nearly 90% chance just four months ago.

That's because, as I mentioned at the outset, recent economic data has taken a decisive turn for the worse, which tells me the recent stock market rally is simply not sustainable.

While the Fed is supposed to base its policy decisions on a balanced assessment of the economic data, especially jobs and inflation, you can bet that Yellen and company are nervously watching corporate sales and profit results too.

Recently in Money and Markets (see: Can Stocks Survive the Earnings Recession of 2015?) I wrote about dismal prospects for third-quarter earnings. In fact, nearly half of S&P 500 companies have reported results so far and profits are on track to decline about 3% year–over-year.

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As usual, most companies are beating lowered expectations, but not by enough to make year-over-year earnings growth positive:

While 77% of companies have reported profits above estimates, only 43% have reported top-line sales above expectations. The biggest culprit being cited by many companies to explain away the sales shortfall is the strong dollar, which is a major drag on overseas sales and profits.

And that's another good reason why the Fed is so reluctant to begin raising interest rates. Central banks globally have cut interest rates more than 500 times since 2008.

With the entire world easing monetary policy now, a Fed rate hike would send the dollar on another parabolic move higher, crushing corporate sales and profits even more.

The U.S. economy is in a precarious situation right now. Deflationary forces have reduced global growth, cutting into U.S. industrial exports, which in turn is hurting profits.


Click image for larger view

U.S. industry is contracting at an alarming rate, as you can see in the graph above, where ALL five of the Fed's regional manufacturing surveys for September AND October came in below zero — meaning widespread contraction in factory orders and current production.

U.S. manufacturing hasn't been this anemic since the last recession in 2009. In fact, it's even worse now than during the global growth scare in 2011. And in 2011, the S&P 500 declined nearly 20% in just a few months!

If corporate profits end up falling again this quarter, as they are now on track to, it will be the second consecutive quarter of slumping profits for corporate America. In other words: a "profit recession."

And that hasn't happened since 2009, when the Great Recession was just ending.

The fact is the Fed has never before hiked interest rates during a profit recession, which is another reason why the chances of a Fed rate hike should keep falling for the foreseeable future.

Good investing,

Mike Burnick

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The investment strategy and opinions expressed in this article are those of the author's and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.

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