After a late-session rally yesterday, the Dow Jones Industrial Average (DJINDICES: ^DJI ) started this morning with the same upward momentum. After the release of the Labor Department's jobs report for May, the index jumped even higher. With a 1.1% gain as of 11 a.m. EDT, the Dow is the biggest gainer of the major indexes. But given that the jobs report missed the mark, why would the market be responding favorably?
The name of the game is speculation
While investing has an innate need for some speculation, the kind that's been dictating the market's moves for the past week is of a different kind. Ever since Ben Bernanke stated that the Fed would be willing to revise its current monetary policy, including a tapering of bond repurchases, investors have been trying to decipher economic data to figure out when such cutbacks would begin. Since the reductions in stimulus are expected to cause a pullback in the market, investors are now responding to signs of positive recovery with caution.
With the labor market being the key component to the Fed's policy, the jobs report is just the latest data to digest. With improvements in the labor market a big part of the monetary policy's aim, today's report signaled to investors that there's no real "danger" coming in the near term. The overall unemployment rate rose 0.1% in May, though 175,000 new jobs were added during the month, and economists have stated that the current rate doesn't really reflect the health of the market. As the labor market continues to struggle along, the Fed will stand by its comments and refrain from any new changes to the current policy. Whew!
Sector-specific effects
One of the sectors viewed to be benefiting largely from the Fed's current policy (and resulting low interest rates) is the nation's banks. Both Bank of America (NYSE: BAC ) and JPMorgan (NYSE: JPM ) have been enjoying a flood of refinancing activity thanks to the historically low interest rates. This is great news for the banks, which are trying to gain ground on the top originator, Wells Fargo (NYSE: WFC ) . Wells commanded an impressive 29% of the mortgage origination market in 2012, with JPMorgan coming in a distant second. Bank of America has stated that one of its main goals is to capture some more market share, though the historical issues with the bank's home loans may be keeping customers away.
While all three may be reaping the benefits of new refinancing activity volume, the low interest rates are taking their toll. Since the new loans are at low rates for long terms, loan portfolios are being generated that will produce much lower revenue than they would have with normalized interest rates. Investing returns have experienced continued pressure since interest rates dropped, putting increased pressure on revenue generation.
The past two weeks have seen a decline in refinancing activity since rates have increased marginally. While this may seem like a problem, many of the bank's top managers have spoken out about the return to normalized interest rates. JPMorgan CEO Jamie Dimon said that though investors should expect a "scary time" as rates normalize, he is looking forward to higher interest rates, as should everyone else. Wells CFO Tim Sloan said that his bank is well positioned for a return of higher rates, though the expected slowdown in refinancings will hit the bank harder than its rivals.
Looking ahead
While the transition period may seem like it will be scary (to use Dimon's word), the return to higher interest rates will help the market and banks in the long run. And as a Foolish long-term investor, knowing that the end result will be positive can help you navigate any potential pullback that results from the Fed tapering its bond buybacks.
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