June 10, 5:00 pm EST
Last week we had signals from the Fed Chair that they were prepared to cut rates if needed.
That’s all the market needed to hear to fuel a bounce back in stocks. And that bounce accelerated when the weak jobs numbers report hit on Friday.
This is the “bad news is good news” dynamic. Souring economic data gives more impetus for the Fed to move. And expectations for lower rates are fuel for stocks.
So, the market is now pricing in an 80% chance of a rate cut at their Julymeeting. But I suspect that’s not soon enough.
If stocks continue the strong recovery, on the expectation of rate cuts coming down the pike, the likelihood of the Fed actually delivering on rate cuts diminishes greatly. To put it simply, the better stocks do, the less likely it is that the Fed will cut. The stock market matters.
Remember, this overhang of concern in markets is less about what’sactually happening in the economy, and more about what might happen (i.e. the prospects that the U.S. economy and global economy may deteriorate IF the stalemate with China continues indefinitely).
I suspect that Trump wants and needs a move from the Fed at their Junemeeting, which is just seven business days away. 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.
With the above in mind, it makes since for Trump to ramp up the trade rhetoric (and any other threatening rhetoric) ahead of that June Fed meeting (keeping pressure on stocks), in attempt to force the Fed’s hand, sooner rather than later.
This would explain why he called into CNBC this morning. Reminding everyone of his hardline stance on China (his indifference on hammering them with tariffs indefinitely), is perhaps his way of trying to tame the stock market recovery. It may sound like a crazy theory (Trump leveraging a monumental trade deal to manipulate Fed policy, in effort to surgically optimize the economic outcome going into the election), but I think it’s happening. And he’s doing it because he can. He’s in the driver’s seat. He has the leverage and he is pulling the levers.
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June 7, 5:00 pm EST
We had the jobs report this morning. As we discussed on Wednesday, the weak ADP report was telegraphing a “below expectations” government jobs report.
Indeed, that’s what we got this morning.
And, while a bad job number is typically seen as bad news for stocks, in a world where the Fed has been on the hot seat to deliver a rate cut, it increases the likelihood of that happening. A rate cut is fuel for stocks, and with that, stocks continued the very strong bounceback, closing near the highs of the week.
What problems would a rate cut solve? It would mostly improve sentiment. A yield curve inversion has been spooking markets now for a while (as it has a record of predicting recessions). Perhaps contrary to what some may think, a rate cut by the Fed should steepen the yield curve. It would not only lower the front end of the curve (shorter term rates), but likely increase longer term rates by improving sentiment (i.e. higher long-term rates on the optimism that the Fed isn’t going to kill the economy through overly-tight monetary policy).
Now, while stocks have continued with a very persistent march higher this week, gold has also marched higher, and the dollar has fallen, and rates have remained near dead lows. What’s going on?
Is it the threat of tariffs hitting Mexico on Monday? I don’t think so. Stocks have well recovered and surpassed the levels prior to Trump’s tweet that threatened Mexico.
There may be something bigger happening.
A couple of weeks ago, we looked at this technical reversal signal in the dollar (chart below) and talked about the prospects of the trade war with China ending in a grand and coordinated currency agreement. The dollar has since been on the move (lower).
What do I mean by a currency agreement? There are a lot of similarities between the U.S/China standoff and that of U.S. and Japan in the 1980s. That was ended with the “Plaza Accord” — an agreement between the U.S., Japan, Germany, England and France. The Plaza Accord was a plan to balance global trade, through a 50% depreciation of the dollar (vs. the yen and d-mark).
As I said a couple of weeks ago, we may wake up one day and find a similar agreement has been made between the U.S. and major global trading partners (which may include China, or not). It might be a deal between the U.S. and China to “revalue” the yuan (i.e. strengthen it). Or it may exclude China (just G3 economies). With the behavior in markets the past few days, it smells like something is cooking.
June 3, 5:00 pm EST
Back on December 19th, the Fed hiked rates into a sharply falling stock market. This turned out be the last rate hike in its “rate normalization program.”
Here’s an excerpt from my Pro Perspectives note from December 19th, following the Fed meeting:
“This sets up for what looks like an ugly finish for the year. Remember, as we discussed on Monday, we talked about the similarities to 1994. The Fed, back in 1994, was also systematically raising interest rates into a low inflation, recovering economy — in anticipation that inflation would quicken. It didn’t happen. They ended up choking off growth.
This is the first time since 1994 that stocks, bonds, real estate and gold have all been losers on the year (negative returns). And the first time cash has been the highest return asset class. As we discussed,the Fed had to reverse course and cut rates in 1995, which finally unleashed the stock market, which finished up 36% that year.
Bottom line: The Fed has been, by their own admission, walking a tightrope trying to raise rates without killing the recovery. They now clearly have signals, in the plunge in stocks and oil prices, that they may have gone too far.“
Fast forward to today, and the markets have clearly signaled that the Fed made a mistake (at least) with the last rate hike.
With that, the rate cut chatter is now loud. The interest rate market is pricing in a 60% chance of a cut at the July meeting. And we’re now hearing more and more aggressive projections for where the Fed will take rates by year end. Barclay’s thinks they will cut three times this year. That’s anticipating a lot of economic deterioration.
Still, with that extreme viewpoint out there, the market is still underpricing the chance of a rate cut this month — at the Fed’s June meeting on the 19th. That sets up for a surprise.
And we may get some signals tomorrow, as Jerome Powell is scheduled for a prepared speech at a Chicago Fed conference (9:55 EST). Interestingly, the conference is called “Fed Listens.” Let’s see how well they are listening to markets.
It’s not uncommon for the Fed to float some policys shift balloons. We saw plenty of it in January, when they went on a public campaign to make clear to markets that they were done with interest rates hikes. They have since moved to a neutral stance. Today we Jim Bullard — St. Louis Fed President, a voting member — say a cut may be “warranted soon” to “provide some insurance” in case of a sharper slowdown.
The 10-year yield seems to keep bleeding lower, forcing the Fed’s hand. The 10-year yield is now 43 basis points below the top end of the Fed Funds target range (2.25 to 2.50%).
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