Remember, last year was the first year since 1994 that cash was the best producing asset class (among stocks, real estate, bonds, gold).
This year, as it did in 1995, the pendulum has swung.
Stocks are up 16% year-to-date. The Dow Jones Real Estate Index is up 19%. Gold is up 11%.
As you can see below, there is a lot of green on the year for global asset prices …
As we’ve discussed for much of the year, what else is similar between the current and 1994-1995 period? We had an overly aggressive Fed, that tightened into a low inflation, recovering economy. In 1995, they did an about face, cutting rates at their July meeting. And now we head into the July Fed meeting with expectations of a 50bps cut.
On that note, we heard from the Fed just days ago, signaling that they were ready to act if conditions deteriorated. And as I said following the meeting: “What is clear, from Powell’s press conference, is that this is all about the China trade deal. If it drags out, sentiment continues to erode. When sentiment erodes, the economic momentum will erode. If that’s the case, they will be reactive, with stimulus (rate cuts and/or slowing the runoff of Treasuries on the Fed balance sheet).”
Today, Jerome Powell was again on a stage talking about monetary policy, at a conference on the Economic Outlook and Monetary Policy at the Council on Foreign Relations. He had a prepared speech and did a Q&A. So what message was he trying to send to markets?
He did a lot of talking. But I suspect his posturing doesn’t matter at this point. This less about him, or the economy, and more about Trump. If Trump were to back off the hardline demands and signal a deal with China over the weekend, the Fed would be off the hook — no rate cut. If the meeting comes and goes, and it’s a clear kick the can down the road, or no deal –we get a cut by the Fed come July (whatever size and scope is necessary).
Let’s take a look at gold as we head into the Trump/Xi meeting scheduled to take place at the end of the week’s G20 meeting.
Gold has been sold all along as an “inflation hedge.” But unless you have Weimar Republic-like hyperinflation, you’re unlikely to get the inflation-hedge value out owning it.
Remember, gold went on a tear from sub-$700 to above $1,900 following the onset of global QE (led by the Fed). Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply. Still, ten years after the Fed’s first round of QE and massive global responses, we’ve been able to muster just a little better than 1% annualized inflation.
If you bought gold at the top in 2011, the value of your “investment” was cut in half just four years later. That’s a lot of risk to take for the prospect of “hedging” against the loss of purchasing power in the paper money in your wallet.
So, gold isn’t a hedge against inflation, it’s a hedge against the worst-case scenario. It’s for sovereign wealth and anyone else that can take delivery, own and control the storage. For almost everyone else, it’s a speculative trade.
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As we end the week, any questions on whether or not the central banks have your back, have been answered.
Just as they have for the better part of a decade, they have no choice but to respond to any shocks that might knock the global economic recovery off path. And as I said yesterday, the major central banks of the world have lined up, because they are unable to predict what Trump will do on trade. To maintain market confidence, they have to posture as if they assume the trade war will go on indefinitely.
On that note, it seems to be priced into the global treasury markets and the gold market that China can’t accept Trump’s deal (or at least can’t deliver on the current demands of the deal). It’s politically unpalatable and an existential threat to the Chinese Communist Party. So, the question is, will Trump end the trade dispute with more bark than bite? Will he do a deal (not the deal) and remove the overhang of uncertainty from the global economy, and an election coming next year. Next week should be interesting, as we await the Trump/Xi meeting at the G20 (scheduled for Friday 6/28 and Saturday 6/29).
As we head into this weekend, markets hang around big levels: record highs in stocks, the big 1,400 level in gold, just above 2% on the 10-year, and closing in on 10k in Bitcoin (a haven for Chinese capital flight).
Stocks traded to new record highs today. Oil was up 6%. The 10-year yield traded below 2% for the first time since the day following the Trump election.
These are all significant signals for global financial markets. But the most important signal of the day was the move in gold.
Remember, the great macro trader Paul Tudor Jones said last week that he thinks a break of $1,400 in gold would quickly bring about $1,700.
Gold exploded to five-year highs overnight in Asia, and traded just shy of the $1,400 level today. Not coincidentally, the pop in gold prices overnight happened when the 10-year yield broke below 2%.
So what is gold telling us? Gold is the bet that the trade war won’t be resolved. And that, along with the sharp decline in global government bond yields this year, is telling us that global central banks will be forced back into highly stimulative policy.
Will it happen? With all of the scenarios that strategists are conjuring up, looking for potential cracks in the economy, it really boils down to “what will Trump do?” If he holds firm on demands of China, then the markets are right (pricing in economic slowdown, deflationary pressures, aggressive monetary stimulus and maybe military war). If he folds/ concedes to get a deal done. The markets are wrong.
In either case, in the near term, ultra-low rates and the prospect of more monetary stimulus is fuel for stocks. And if the trade war were to end with a deal, the stocks would have the tailwinds of low rates and an economy that would probably pop to 4% growth.
The Fed held the line on rates today, passing up an opportunity to surprise markets with a cut. The economy seems to be in position to easily absorb it, with soft inflation.
Not surprisingly, they did make plenty of efforts to massage market sentiment. They stayed on message that they are prepared to act to sustain the economic expansion. And half of the Fed Presidents now see at least a cut by the end of the year.
What is clear, coming from the Fed Chair’s press conference, is that this is all about the China trade deal. If it drags out, sentiment continues to erode. When sentiment erodes, the economic momentum will erode. If that’s the case, they will be reactive, with stimulus (rate cuts and/or slowing the runoff of Treasuries on the Fed balance sheet).
On the other hand, if we get a deal on trade, the Fed is off the hook — no rate cut.
And they seem to be comfortable, at the moment, holding their fire as long as economic conditions are still holding solid.
The question now is, will they be tested? Sure a deterioration in sentiment can show up with consumer activity or business confidence. But more likely/ more immediately it would be in financial markets.
With stocks just a percent off of highs, they aren’t being tested at the moment. However, a sharp move lower in stocks and I suspect we would see the Fed step in, and quickly. The other spot that could test them is the yield curve.
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We’ve talked about the prospects of the Fed surprising tomorrow.
Maybe beating the Fed to the punch, we had a surprise this morning–from Europe. In a prepared speech at an ECB forum today, Mario Draghi telegraphed more monetary stimulus to come and maybe soon. Cutting rates would take euro zone rates into negative territory. They could also restart QE–adding to an already $3 trillion worth of assets they purchased between 2015 and 2018.
That news sent stocks and commodities higher this morning, and global rates lower.
But keep in mind, a powerful tool used by the key central banks in the world over much of the past decade has been tough talk. It has been especially effective for the ECB. Draghi fought off a speculative attack on the vulnerable European soveriegn debt market in 2012 by promising to do “whatever it takes.” That was a specific threat to buy unlimited Spanish and Italian government bonds to crush the speculators that had run rates up to unsustainable levels. The threat worked and government bond yields in Italy and Spain fell sharply, avoiding what looked like a cascade of debt defaults in Europe. He didn’t have to buy a single bond, until 2015, when the ECB was ultimately forced to follow the Fed and BOJ with QE.
What about this time? Is it talk or is the ECB ready for more action?
Probably the latter, especially given the likelihood that the Fed has ended its tightening cycle and has prepared markets for a rate cut.
Still, the news from the ECB today makes it clear that the two major central banks (the Fed and the ECB) are now focused on creating tailwinds for their respective economies (again) rather than creating headwinds. And this positioning is all dependent upon the direction Trump’s trade war with China takes.
On that note, Trump announced this morning that talks with China are back on. That’s good news for markets. The question is, is Trump ready to do a deal? Has the interest rate market already given Trump the rate cut he has wanted? We go into the Fed meeting tomorrow with the 10-year yield trading almost 125 basis points lower than it was in just November of last year. And the last move the Fed made was a hike.
As we discussed last week, if the Fed wants to surprise markets and get maximum gain from a rate cut, it would serve them well to cut rates on Wednesday, and not wait until the July meeting.
As we head into the meeting, the market is pricing in just a 20% chance of a cut. That seems well underpriced, given that there’s a near certainty of them moving next month. A surprise cut would be rocket fuel for the stock market.
With the Fed looking to reverse course on monetary policy, more than a decade removed from the failure of Lehman Brothers, we still still have 60% of global central banks in easing mode, with full-bore quantitative easing in Japan.
That said, the Fed is looking for what will likely be an “insurance cut” — just to solidify the economic expansion. And if a Fed cut is followed by trade resolution, the U.S. economy could/should be in for a boom period. And that would likely flip the switch on global monetary policy.
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Next week we have the three central bank meetings on the agenda: the Fed, the Bank of Japan and the Bank of England.
The market is still pricing in just a 25% chance that the Fed will cut rates on Wednesday. But as we’ve discussed, I suspect that Trump wants and needs a move from the Fed at their June 19 meeting. The G20 meeting comes later this month (June 29-30) where Trump and Xi are expected to have a sit-down to discuss the trade deal. With a rate cut under his belt, Trump might feel more compelled to claim victory on the China trade talks and do the deal, giving himself enough runway into the 2020 elections to have a booming stock market and booming economy.
As we head into the weekend, let’s take a look at some key charts …
Here’s a look at stocks …
We’ve had a 6.7% bounce in stocks since Jay Powell (the Fed Chair) signaled that the Fed was prepared to act, if necessary, to sustain the economic expansion. As we’ve discussed, ironically the better stocks do, the less likely it is that we will see a Fed rate cut. With that said, Trump kept a lid on stocks this past week by ramping up the rhetoric on China.
What message is the interest rate market giving? Not as comfortable a mood as we’re getting from stocks. Here’s a look at interest rates …
Yields traded back down to the two-year lows today (below 2.06% on the 10-year government bond yield). And German yields traded down to new record lows today (-27 bps).
And here’s a look at crude oil, which closes the week up a couple of bucks from the worst levels of the week …
But we had another run at the important $50 level on Wednesday. As we discussed this week, the prospects of a break below $50 in oil has to be factored into the Fed’s view on inflation (i.e. it creates downward pressures) and for vulnerabilities in the economy.
So, this past week we revisited the lows of the recent declines in rates and oil. But stocks held steady, well above the June 3 lows.
I suspect we’ll see weaker stocks into Wednesday’s Fed meeting. If the Fed wants to surprise markets and get maximum gain from a rate cut, it would serve them well to cut rates on Wednesday, and not wait until the July meeting (where the market is pricing in a near certainty of a cut).
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Yesterday we talked about the plunge in oil prices and the importance of holding above the big $50 level. And oil gets a big bounce back today on the Iranian attack of two oil tankers in the Middle East.
Iran has made threats, in the past, to choke off global oil supply in the narrow strait (Hormuz) that about 30% of the world’s crude oil passes through. Today’s attack follows an attack on Saudi tankers last month. So Iran is posturing to deliver on threats of disrupting global oil supply.
This all stems, of course, from Trump’s efforts to bring Iranian oil exports to zero (sanctions that were upgraded back in April) — to get them back to the negotiating table on weapons of mass destruction.
Without getting into speculation of where this will end, let’s just take a look at gold, which has gotten a renewed “fear of the unknown” bid this month. A conflict with Iran would fall into that category. In an interview yesterday, the great macro trader Paul Tudor Jones called gold his favorite trade over the next 12-24 months (for a number of reasons). He said if it breaks $1,400, it will quickly push to $1,700.
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Remember, last week we talked about why $50 is a very important level for oil.
A recent Dallas Fed survey has the breakeven level for shale producers at $50. In other words, the shale industry needs oil prices above $50 to produce profitably.
If the shale industry becomes unprofitable, that becomes a problem. As we found in 2016, when oil prices crashed, the shale industry became vulnerable. Defaults started lining up in the industry, which made banks vulnerable. When banks are vulnerable, credit tends to tighten and the financial system can quickly become unstable.
Now, as we know, the price of oil bounced from that $50 area last week, but we’re getting another test today. Oil was the mover of the day — down close to 4%, and back under $51.
This, I suspect, will play a very important role in the Fed decision next week.
Despite the fact that expectations point to a rate cut in July, we’ve discussed the pressures building that might lead the Fed to move next week (which would be a big surprise for markets). Oil plays into that scenario.
Stocks and crude oil have been two clear influences on Fed policy over the past few years. The latter weighs on inflation. While the Fed claims to ignore the influence of food and energy in their inflation measure, they have a history of acting when oil moves sharply. On that note, oil is down 22% over the past year. And, again, we’re testing an important level that can have spillover effects into the economy. That’s why a sharp decline in oil prices tends to influence stocks. That’s why the charts of stocks and oil have tracked so closely …
So, we’ve had a nice bounce in stocks over the past week or so. We had the same for crude. But now crude is back testing the lows of this decline.
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