Why Fiscal Stimulus Could Be The Catalyst To Put A Top In Bonds


September 6, 2016, 3:30pm EST

As we headed into the holiday weekend, stocks were sitting near record highs, yields were hanging around near record lows, and oil had been sinking back toward the danger zone (which is sub $40).

In examining the relationship of those three markets, each has a way of influencing the outcome and direction of the others.

First, the negative scenarios: A continued slide in oil would soon sink stocks again, and send yields (the interest rate outlook) falling farther. Cheap oil, in this environment, has dire implications for the energy business, which has a cascading effect, starting with banks, which effects credit and the dominos fall from there.

What about stocks?  When stocks are falling, in this environment, it’s self-reinforcing.  Lower stocks, equals souring sentiment, equals lower stocks.

What about yields?  As we’ve seen, lower yields are supposed to promote spending and borrowing.  But, in this environment, it comes with trepidation.  Lower yields, especially when much of the world’s government bond markets are in negative yield territory, is having a stifling effect on economic activity, as many see it as a signal of another recession coming, or worse.

Now, for the positive scenarios.  Most likely, they all come with intervention. That shouldn’t be surprising.

We’ve already seen the kitchen sink thrown at the stock market.  From a monetary policy standpoint, the persistent Fed jockeying through much of the past seven years has now been handed over to Japan and Europe.  QE in Europe and Japan continues to promote stability, which incentivizes the flow of capital into stocks (the only liquid alternative for return in a zero and negative interest rate world).

And we’ve seen them influence oil prices as well, through easing, currency market intervention, and likely the covert buying of oil back in February/March of this year (through China, ETFs via the BOJ or an intermediary Japanese bank).  Still, OPEC still swings the big ax in the oil market, and it’s been OPEC intervention that has rigged oil prices to cheap levels, and it looks increasingly likely that they will send oil prices higher through a policy move.  The news that Russian and Saudi Arabian might coordinate to promote higher oil prices, sent crude 5% higher on Monday.

As for yields, this is where the Fed is having a tough time.  They want yields to slowly climb, to slowly follow their policy guidance.  But the world hasn’t been buying it.  When they hiked for the first time in December, the U.S. 10 year yield went from 2.25%, to 2.30% (for a cup of coffee) and has since printed new record lows and continues to hang closer to those levels than not (at 1.53% today).  Lower yields makes it even harder for them to hike because it’s in the face of weaker sentiment.

Last week, we looked at the U.S. 10 year yield. It was trading in this ever narrowing wedge, looking like a big break was coming, one way or the other, following the jobs report on Friday.  It looks like we may have seen the break today (lower), following the week ISM data this morning.

What could swing it all in the positive direction?  Fiscal intervention.

As we discussed on Friday, the G20 met over the weekend.  With world government leaders all in the same room, we know the geopolitical tensions have been rising, relationships have been dividing, but first and foremost priority for everyone at the table, is the economy.

Even those opportunistically posturing for influence and power (i.e. Russia, China), without a stable and recovery global economy, the political and domestic economic outlook is bleak.  So we thought heading into the G20 that we could get some broader calls for government spending stimulus was in order.

The G20 statement did indeed focus heavily on the economy. They said, “Our growth must be shored up by well-designed and coordinated policies. We are determined to use all policy tools – monetary, fiscal and structural – individually and collectively to achieve our goal of strong, sustainable, balanced and inclusive growth. Monetary policy will continue to support economic activity and ensure price stability, consistent with central banks’ mandates, but monetary policy alone cannot lead to balanced growth. Underscoring the essential role of structural reforms, we emphasize that our fiscal strategies are equally important to supporting our common growth objectives.”

Keep an ear open for some foreshadowing out of Europe to promote fiscal stimulus – the spot it’s most needed. That would be a huge catalyst for “risk assets” (i.e. commodities, stocks, foreign currencies) and would probably finally signal the top in the bond market.

After a fairly quiet August, we have a full docket of central meetings in the weeks ahead, starting this week.  The European Central Bank meets on Thursday.

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