Financial Review

Hawkish

..Fed hikes rates 25 basis points. Two more hikes on tap for 2018. AT&T gets approval for acquisition of Time Warner. More M&A in the wings.

Financial Review by Sinclair Noe for 06-13-2018

DOW – 119 = 25,201
SPX – 11 = 2775
NAS – 8 = 7695
RUT – 5 = 1676
10 Y + .02 = 2.98%
OIL + .26 = 66.62
GOLD + 3.60 = 1299.80

 

The Federal Reserve increased the target range for its benchmark interest rate to 1.75%-2%. This is the second rate hike of the year and seventh since the financial crisis. The Fed had indicated that it would raise rates 3 times in 2018, but with today’s announcement they indicated they will probably raise rates 4 times (or 2 more times) this year, depending on data.

 

Fed Chairman Jerome Powell, speaking at a news conference after the Fed’s two-day meeting, said the economy has strengthened significantly since the financial crisis and is approaching a “normal” level where monetary policy may no longer be needed to either encourage or discourage economic activity. A statement released at the end of the Fed’s two-day meeting took several steps to show officials no longer view the United States economy as needing a boost and are instead beginning to worry more about the threat of inflation.

 

Officials noted that economic activity has been rising “at a solid rate” — a change from their May statement, when they called the rate “moderate.” Quarterly economic projections released at the meeting showed Fed officials expect the economy to grow at a 2.8 percent rate this year, up from a 2.7 percent forecast in March. Officials also now predict the unemployment rate to dip to 3.6 percent by year’s end, down from a forecast of 3.8 percent in March. Officials raised their headline inflation rate forecast for the year as well, to 2.1 percent from 1.9 percent. The Fed now predicts inflation will run slightly above its target rate of 2 percent through 2020, at 2.1 percent each year, a slight overshoot that Fed officials have roundly indicated they are comfortable with.

 

The latest reading of the Consumer Price Index, released on Tuesday, showed headline inflation and so-called core inflation, which strips out volatile food and energy prices, continuing to rise. The Fed prefers a different inflation measure, the personal consumption expenditures index, which currently stands at 1.8% inflation year-over-year, and is expected to touch 2%. The economic projections released today, which represent the median forecast of FOMC officials, echo those expectations. Officials raised their projections of both headline and core inflation. Today, a new report shows producer prices increased more than expected in May, leading to the biggest annual gain in nearly 6-1/2 years, the latest sign of a gradual building up of inflation pressures. The producer price index for final demand rose 0.5 percent last month, boosted by a surge in gasoline prices and continued gains in the cost of services. The PPI edged up 0.1 percent in April. In the 12 months through May, the PPI increased 3.1 percent, the largest advance since January 2012.

 

There were some changes to the language in the Fed’s published statement. Policymakers removed a line stating that “market-based measures of inflation compensation remain low” and several sentences that expressed caution over the Fed’s future rate moves, including that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

 

With another rate hike, borrowing costs will head even higher for consumers. Americans with credit cards, adjustable-rate mortgages and home equity lines of credit will see their monthly payments rise. All are revolving loans with variable rates that are directly affected by the Fed’s move. Average credit-card rates are 17%, according to Bankrate.com. For a $10,000 credit-card balance, a quarter-point hike is likely to add $25 a month in interest. Four rate hikes this year would mean an extra $100 per month in interest on this type of loan. The rate hike today will result in an additional $2.2 billion in credit card interest.

 

Rates for home equity lines of credit are much lower at 5.92%. A quarter-point increase on a $30,000 credit line raises the minimum monthly payment by just $6 a month. By contrast, rates on adjustable-rate mortgages are modified annually. So the impact may be delayed, but then it could bite. Three to four quarter-point hikes in 2018 likely would boost the monthly payment on a $200,000 mortgage by $84 to $112.

 

Car buyers may feel it, too, though they’re still benefiting from a competitive auto loan market that’s keeping borrowing costs low. A quarter point rate hike will likely increase the monthly payment for a new $25,000 car by $3. Existing loans would be unchanged.

 

Any effect on 30-year mortgages and other long-term loans would likely be muted. The average 30-year fixed mortgage rate already has climbed from 4.15% to 4.54% since Jan. 1 largely because investors expect federal tax cuts and spending increases to push inflation higher. But the rate is down from a recent high of 4.66% in late May. The rate hike today is already figured into mortgage rates. Existing fixed-rate mortgages are not affected.

 

The war on savings accounts continues. Don’t expect a fast or equivalent rise in your savings accounts or CD rates, many of which pay interest of 1% or less. Those rates have barely budged the past year despite the Fed’s hikes. Average one-year CD rates are expected to rise from about 0.5% to 0.7% by year-end. Yet a handful of online and community banks, credit unions and money market mutual funds that are hungrier for deposits are paying as much as 2.5% on a one-year CD, up from 2.15% in March. And top savings and money-market rates are nearing 2%. That’s about the rate of annual inflation. Simply saving has not been able to keep up with inflation over the past decade.

 

The dollar reversed losses against a basket of currencies following the Fed’s rate decision while prices for US Treasuries fell. Yield on the 10-year note topped 3% before moderating at 2.98% Stocks dropped, but market reaction to the Fed was muted. The Nasdaq Composite hit an intraday record before slipping 8 points.  No surprises, no shocks.

 

In a press conference after the release of the FOMC policy statement, Chair Powell took a question about the impact of trade policy. Even though the Fed Beige Book included many mentions of trade policy, Powell said it did not fall under the Fed’s mandate, therefore he would not address the issue because it was not showing up in economic data. However, he acknowledged that he was beginning to hear reports of companies holding off on making investments and hiring. Powell also called the slow wage growth “a bit of a puzzle” saying the Fed “certainly would have expected wages to react more to the very significant unemployment rate.” Powell also announced that in January he will begin holding a news conference after every monthly Fed meeting, instead of just on a quarterly basis, as is currently the norm.

 

So, the Fed raised rates as expected; their forecast now points to 2 more rate hikes this year, but they will move slowly and carefully watch all incoming data.

 

 

A federal judge approved AT&T’s $85 billion purchase of Time Warner yesterday, handing the telecom giant a massive victory that could hamstring U.S. regulators seeking to block big corporate mergers. The case is viewed as a bellwether for other deals waiting in the wings. Corporations increasingly have been seeking to expand their reach by buying up companies in different lines of business. The judge’s decision, which is allowing AT&T to merge with Time Warner without conditions, shows the federal government may struggle to rein in such mergers. In handing down his ruling, federal judge Richard Leon said that the Justice Department failed to provide sufficient proof that the deal would harm competition or consumers, telling a packed courtroom that the government’s economic analysis “rested on improper notions.” Leon warned the U.S. government against seeking a stay on the merger if it brings an appeal, which is legalese for telling the regulators they had a rotten case.

 

First to step up to the plate – Comcast is making a play at 21st Century Fox’s TV and film assets. Hoping to derail Disney’s pending, stock-based $52.4 billion deal with Fox, Comcast is stepping in with a higher, all-cash offer for $35 per share, which totals approximately $65 billion. The move is likely to trigger an intense battle between Comcast and Disney as 21st Century Fox and the Murdoch empire weigh which is the better option. Fox’s board of directors is scheduled to vote on the Disney deal on July 10th. Comcast had reportedly been waiting to see whether AT&T’s acquisition of Time Warner would be approved  before formally making its offer for the bulk of 21st Century Fox’s entertainment assets.

 

This could open the floodgates for other vertical mergers, including CVS’s acquisition of Aetna. Beyond that, if Google and Facebook get the signal the court will not let the government block vertical transactions, then the door is open for them buying more artificial intelligence firms, more messaging firms, more data-gathering firms. The Justice Department’s loss could also spread to other types of mergers, such as when companies try to gobble up competitors in the same sector – transactions known as horizontal deals. A looming example is the pending merger of Sprint and T-Mobile, a $26 billion combination of the country’s third and fourth-largest wireless companies.

 

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