With the semi dovish speech by Jay Powell yesterday we have ushered in ‘Goldilocks’. For me this means that I am now expecting as few as 1 Fed Funds rate hike in 2019.
All is great for now and the next many months as stocks have a more reasonable price and the 10 year treasury yield has moderated to the 3.06% area.
The Fed funds rate hike for December will happen–only the severe black swan event could change the inevitable hike. Thats fine–our money market is now at 2.16% and this will raise it a bit more–a nice cash alternative.
In May, 2018 I wrote the following–
“The bottom line is I still believe that 3.25% on the 10 year is the right number for the end of the year. If we saw this rate on a straight line basis the rates would move higher by 4 basis points a month throughout the balance of the year. We would be very happy with that result.”
Since May the average $25/share preferred stock fell from $24.86 to the current level (as of last Friday) of $23.72. This tells me that the average perpetual preferred holder has taken a 4% hit since May—so for all of us that are “green” we have done a good job–even if it is 1% green.
While we hit the 3.25% a bit earlier than my expectations the ‘stars aligned’ for the most part. Even a blind squirrel finds a nut on occasion.
So back to 2019. I believe we will see maybe a Fed Funds rate hike in June–and of course that is a maybe–and that is it for 2019. I see GDP growth starting to taper off the 1st quarter and I hope maintains a 1.5-2%% growth through the end of the year. Employment will weaken–not bad, but starting as early as January job growth will start stalling out–maybe 100,000-150,000 new jobs monthly instead of 200,000. Inflation is a big unknown–but outside of the tariff situation with China it would seem reasonable to expect 2-2.5% next year. The wage inflation I expected probably won’t happen much–a slowing economy will temper future wage increases.
Much of my data is purely anecdotal–what do I see in my neighborhood. Housing is an issue–high prices and high interest rates. Refinancing of mortgages is at the lowest level in 14 years and this ‘dry powder’ has fueled the strong consumer (like it did 10 years ago). At the margins a 1% increase in housing interest rates is painful to modest folks. Apartment building has been going gangbusters and rents are at sky high prices–overbuilt? Credit standards in auto loans and house mortgages are too low–and this will come home to roost someday (not 2019 likely). We need to watch Consumer Confidence very closely–I believe this will telegraph the future–thus far it has held up better than I thought it would, but with high profile job cuts at General Motors etc consumers begin to ponder their own circumstances and maybe pull in their horns a bit.
For me this personal forecast allows me to ponder additional perpetual preferred purchases. The plan is to buy maybe a mortgage REIT perpetual (don’t know which but there are plenty to choose from), I am also looking at American Homes 4 Rent preferreds–they have numerous issue outstanding and have current yields just shy of 7% and the strong balance sheet can withstand rent stagnation. Maybe an equity REIT preferred–not sure which one. These are moves I think I will make starting the end of December.
So the bottom line is we think that “interest rate risk” is minimal for 2019, but of course with perpetuals there remains “duration risk”.
Lastly I have been concerned about the Federal deficits–we should all worry about those. To date the huge deficits have been sopped up by bond buyers–BUT, tomorrow or next week or next year (or 5 years from now) buyers will reject the financials of the U.S. It is near impossible to factor such an event into our financial plans–the day is coming–we just don’t know when it is going to occur.
My normal warning is that this is simply a lot of rambling on our part–how we see things and how we react. Each individual is responsible for their own investments for their situation.