U.S. Bond Market Week In Review: Why The Fed Is About To Make A Mistake In Raising Rates

The consensus is the Fed will raise rates at its next meeting. The latest employment report all but baked this into the cake. However, I’m not so sure this is a good idea. First, there are three economic indicators – industrial production, corporate profits and bond yields – that signal we’re closer to the end of an expansion then the beginning. A rate hike in this environment may do more harm than good by adding additional counter-stimulus to the economy. Second, I believe the Fed misunderstands the current inflation dynamic. The hawks argue low oil prices are the primary reason for low inflation. However, I believe the ending of the commodity super-cycle is the real reason for weak inflation. If this is correct, low prices will persist for a longer period of time.

Industrial Production

Industrial production is one of four components of the Conference Board’s Coincident Economic Indicators. However, it has only been strongly positive in one of the last six months:

The problem started in the 1H13, when new orders for durable goods stopped rising. Save for a very large spike in mid-2014, this statistic has stalled at the 240,000 level since.

Next, industrial production peaked in December 2014 and has moved sideways since:

Thanks to the strong dollar and weaker emerging economies, new export orders for industrial goods are also weak:

And in the latest ISM manufacturing report, new orders dropped below 50, indicating manufacturing weakness is more widespread than just the oil sector:

The latest anecdotal comments from the ISM manufacturing report highlight the basic problems:

“The oil and gas industry is realizing that [the] ‘low’ oil prices are now the new reality with expectations to continue at this level for some time.” (Petroleum & Coal Products)

“Still seeing deflation in raw materials.” (Chemical Products)

“Bookings and new orders are lower than expected.” (Computer & Electronic Products)

“Automotive remains strong.” (Fabricated Metal Products)

“Business is still good.” (Transportation Equipment)

“Downturn in China and European markets are negatively affecting our business.” (Machinery)

“Strong dollar is slowing our sales to China as they can buy in Europe.” (Primary Metals)

“Medical device continues to be strong.” (Miscellaneous Manufacturing)

“Incoming orders have leveled off from the summer.” (Furniture & Related Products)

“Month-over-month conditions are stable.” (Food, Beverage & Tobacco Products)

The weak oil and gas market, strong dollar and weak emerging economies continue to weaken the sector. None of these factors is going away any time soon. Oil recently hit a seven year low, the dollar is strong thanks to the Fed rate hike and emerging economics are being hit by China’s slowdown.