When Will Rates Increase?

 |  Includes: DIA, SPY
by: Angelo Airaghi

They will stay low for some more time. However, past history tells us Fed Funds rate start to increase every 4/5 years. Unemployment could target 8.0%-7.8% in the coming months. The longer-term picture remains bullish. What if Mr. Hollande wins?

2013 or 2014?

This week, the FOMC will meet for two days to discuss the economic situation in the U.S and abroad. Of course, Fed funds rate will be brought to the table again. During the meeting of January, eleven members forecasted rates will be raised before the end of 2014. Other six members expected instead Fed Funds to remain unchanged until the end of 2014. In March, statements were in line with previous meetings, although members were more optimistic about the economic conditions. Further easing was not expected.

What will happen this time? Since January, the unemployment rate improved further. Private consumption held up fairly well. The Feds of New York and Philadelphia are showing a normalization in the U.S. manufacturing sentiment survey. The Fed wants to avoid the mistake made in 2004, when it increased rates prematurely. Interest rates will remain accommodative, until the economy will show consistent results. When rates could rise? Since 1954, Fed Funds were increased roughly every 4/5 years bottom-to-bottom (58/62/67/72/77/81/87/93/99/04/09). The longest period of decline lasted for five years (1989/1994).

Battling unemployment?

Last week, President Obama announced a plan to allow those looking for jobs to keep unemployment insurance benefits, while working for eight-week trial period. It will be at no-cost to the employer, who then has the discretion whether or not to hire the trained employee. The plan, negotiated with congressional Republicans in February, is designed after the unemployment program in Georgia and is already effective in a few states. The risk is for employers using "free" labor-force indefinitely. Nonetheless, it is also an opportunity for job seekers to touch-base again after weeks/months of job searches.

In effect, unemployment is a big challenge. From its current rate (0.08% each month since 2010), it could decline to 8.0%-7.8% by the end of 2012. However, the longer-term picture remains bullish. Since 1948, the unemployment rate had two bullish cycles (1952/61, 1969/1982). Movements lasted for 9/13 years and extended 63%-67% top/bottom. They all climbed in three distinct waves before collapsing. Within these secular bull-cycles, the unemployment rate topped/bottomed every 4/6 years. Corrections have instead continued for 1/3 years top/bottom. How would it fit in today's scenario? Unemployment began in 2000. It topped in 2003, bottomed in 2007 and completed the second wave in 2009. It extended for 60% top/bottom. A third and final wave is still lacking. It could be expected between 2012/2013, if history repeats itself.

What if Mr. Hollande wins?

The first round of the French political elections has seen Mr. Hollande prevailing over Mr. Sarkozy for a few points. Le Pen was third with almost 20%. Next month, the two contenders will be running neck-to-neck for the final countdown. The socialist Hollande has a small advantage over his adversary. As opposed to Sarkozy, Hollande wants to re-discuss the fiscal compact adopted in December 9/12. He expects the E.C.B. to start issuing eurobonds to reduce Europe debt. Finally, he believes the E.C.B. should lend directly to governments instead of giving money to the banks. In reality, the decision-making process is very long and tedious in Europe. France cannot do anything unilaterally and needs to convince Germany to change current path. The continent stays under pressure. Last week, the Spanish Treasury raised a total of euro 2.5 billion. The demand was good. However, Spain had to offer higher yields to place the bonds. Investors are still caution about the capacity of Madrid to reduce regional spending. So, the 10-year rate still sits near the important level of 6.0%.

The I.M.F. published a new forecast on world growth. The institution expects the euro zone to contract 0.3% this year and to expand 0.9% in 2013. Greece and Portugal are facing deep recessions, along with Italy and Spain, albeit to a lesser degree. For the I.M.F., most European countries will struggle to public deficit reduction target in 2012 and 2013, but additional austerity measures should be postponed. German growth prospects are at 0.6% this year. The economy has held up quite well so far. Following a sixth consecutive increase, the IFO business climate index reached its highest level in April. The expectation index was instead unchanged, as companies are concerned that the economic contraction will at some point reduce exports. The International Monetary Fund (I.M.F.) wants to raise additional USD 430 billion as an insurance against future crisis and to reassure the markets. Negotiations are ongoing. EUR/USD is oscillating between 1.35/1.26. A correction to the lows is still in the cards. Nonetheless, a move above 1.3550 will target 1.37, 1.39.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.