Market Is UNDER-Estimating Rate Cut Chances For June

May 31, 5:00 pm EST

We end the month of May today.  Things were going quite well for markets, with stocks sitting on record highs, until Trump did this over the first weekend of the month …

 

 

With the above in mind, let’s look back at my May 6th note: “Why would Trump risk complicating a deal, even more, by threatening China with a deadline/tariff increase? Because he has leverage. He has a stock market near record highs, and a strong economy and the winds of ultra-easy global monetary policy at his back …

So, Trump has a win–win going into the week. If the threat works, he gets a deal done, and likely gives less to get it done. If China backs off, stocks go down, and he gets the Fed’s rate cut he’s been looking for–stocks go back up.”

As we know, China walked.  And Trump is now using a similar position of strength to influence policy with Mexico.  As such, stocks have now fallen nearly 7% from the highs. And the prospects for a Fed rate cut are looking very strong.

How strong?  The interest rate market is pricing in a 90% chance of a rate cut by year end, and a 60% chance of a two rate cuts.  But despite the sharp decline in global interest rates, the market seems to be well underestimating the chances for a Fed rate cut this month — at the June 19 Fed meeting.

There are two clear influences on Fed policy over the past few years.  Stocks and crude oil.  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.  And inflation is already running at very soft levels.  On that note, what was the biggest loser for the day, week and month?  Crude oil.  Crude was down 7.5% today, 10% for the week, and 16% for the month.

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Q1 Growth Number Is A Reminder That The Economy Is Good

May 30, 5:00 pm EST

The first revision of Q1 GDP came in this morning, in-line with expectations (at 3.1%).  As yields swoon, and stocks have given back some gains for the month, this growth number today is good reminder that the state of the U.S. economy is good. 

Remember, back in April, the first look at Q1 GDP came in as a huge positive surprise (at 3.2%).   Many were expecting it to be a terrible quarter.  Goldman Sachs thought the quarter would produce just 0.7% growth.  They were wrong, and they weren’t alone.  At the end of the first quarter, the Atlanta Fed’s GDP model was estimating that the economy grew at only 0.3% in Q1.

With that in mind, don’t get too caught up in the souring growth story.  At the moment, the consensus view on Wall Street is for Q2 growth to come in at 1.8%.   And the Atlanta Fed model is looking for 1.3%.  Both are well lower than the White House envisioned 3%+ growth trend.

But, for perspective, there are some clear factors working in favor of the higher (not lower) growth case.

The job market is strong.  We have monthly new jobs running at a 12-month average of 218k.  That’s well above pre-financial crisis average monthly job growth. The unemployment number at 3.6% is the lowest since 1969.

Most importantly:  Wage growth has been on the move for the past 18 months, now sustaining above 3%.  And Q1 productivity came in at 3.6%, the hottest productivity reading in almost a decade.  The economy can grow by expanding the size of the workforce or the productivity of the workforce.  We’re finally getting solid productivity growth.

 

Low Yields Are Overstating Risks In The Global Economy

May 29, 5:00 pm EST

We’ve talked about the signal the interest rate market is giving: with rates at these levels, the bond market may force the Fed’s hand — forcing a June rate cut.

Still, the slide in the 10-year yield from 2.75 (in March) to 2.20 (the low today) is well overstating the risks in the global economy.  That’s more than 100 basis points off of the highs of just six months ago.  And the high to low of the last five trading days has been almost a full quarter point (23 basis points).  It makes no sense.

Many would assume it’s related due to the trade standstill.  But the IMF has only cut its growth estimate by 3/10ths of a percent from the tariff escalations.  That still projects a 3% growth from the global economy (much better than the average of the past 10-years).

Meanwhile, a U.S. 10-year and 2.20%, and German and Japanese yields well in negative territory are pricing in global recession (if not worse).  Is Japan buying U.S. Treasuries, and therefore pushing down global yields?  Maybe.

As we know, the slide in yields has weighed on confidence, and therefore stocks for the month of May.  But today, we ran into a huge technical level in the S&P 500 — the 200-day moving average.  And we had a big bounce.  I suspect we’ve seen the bottom of this move in stocks and yields.  We shall see. 

 

 

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The Bond Market May Force The Fed’s Hand

May 28, 5:00 pm EST

We head into the last week of May, with major global stock markets down in the neighborhood of 5% for the month.  And with major global interest rates at the lowest levels since late 2016-2017.

With this in mind, let’s revisit how we opened the month of May.

On May 1, U.S. stocks had just put up the best opening four months since 1999.  But the interest rate market was continuing signal that the Fed had made a mistake in its rate hiking campaign — specifically the December rate hike.

On a related note, we closed the first day of May with a sharp sell off in stocks, and we looked at this chart …

 

 

As you can see, the S&P 500 put in a big technial reversal signal — a bearish outside day.

With this technical setup, I said in my May 1 note:  “you have to ask the question:  Can stocks force the hand of the Fed, again?” … i.e. can a lower stock market force the Fed to cut rates — to take back the December mistake.

Here we are, twenty-seven days later, and stocks are down about 5%.  That reversal signal did indeed predict the decline.  But the decline hasn’t been messy like the slides of the fourth quarter.  It has been orderly, and I suspect it’s not forcing the Fed’s hand.

But, what may force the Fed’s hand is the the bond market.  Consider this, the last time U.S. 10-year government bond yield was at these levels, 2.25%, the Fed Funds rate was HALF of current levels (1.25% in Q3 of 2017 versus 2.5% today).  This disconnect between what the market judges to be the appropriate interest rate and what the Fed judges the appropriate level, is causing the dreaded yield curve inversion signal that is scaring markets. If things stay here, that’s probably good enough for a June (19) rate cut.

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Watch Dollar For Signals On A Plaza Accord 2.0

May 24, 5:00 pm EST

We’ve talked this week about the potential for a Plaza Accord 2.0.

As we discussed, the trade war has been manufactured by more than three-decades of China’s currency war.  It only makes sense that it can only be resolved with a primary focus on the currency.  We may find that if/when the U.S./China stalemate ends, it will be with a grand and coordinated currency agreement.
Back in 1985, the U.S. was in a fight with Japan over the imbalance in trade.  The Reagan administration ultimately brokered an agreement (the Plaza Accord) between the U.S., Japan, Germany, England and France.  That resulted in a 50% devaluation of the dollar.
The China fight looks very similar.
With that in mind, we should keep a close eye on how currencies are trading.  And today, things were moving.
Global rates were very heavy today.  Stocks were heavy all day.
Generally, in the post-financial crisis world, that would mean a strongerdollar (i.e. a higher risk environment has tended to result in global money moving into the relative safety of dollars).  That was the case as through Asia and Europe today with the dollar hitting the highs of the past twelve months.  But when U.S. stocks opened, the dollar had a big reversal.

 

You can see in the chart above, the dollar index put in a bearish outside day (a key reversal signal) — something to keep an eye on for clues. 

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This Is How The Trade War May End

May 21, 5:00 pm EST

With the stalemate on U.S./China trade talks, let’s take a look today at how this may end.

A lot of attention has been given to trade quotas, intellectual property theft and the challenges U.S. companies have accessing Chinese markets.  What hasn’t been talked about as much is the currency issue.  Yet China’s currency is at the core of it all.

China has used a weak currency to leapfrog almost the entire world over the past 30+ years, capturing 15% of the global economic market share and rising to an economic power.  They’ve gone from a $350 billion economy in the early 80s, to a $13 trillion economy today (the second largest economy in the world).

That’s how they got here, and we’ve talked in recent weeks how they are attempting to stay here …. going back to what they know, weakening the currency, as a tool to fight the impact tariffs.

With that, the trade war has been manufactured by more than three-decades of China’s currency war.  It only makes sense that it can only be resolved with a primary focus on the currency.  We may find that if/when the U.S./China stalemate ends, it will be with a grand and coordinated currency agreement.

With that, a lot of comparisons have made between the U.S/China standoff and that of U.S. and Japan in the 80s.  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).

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).

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This Is China’s Trade War Weapon

May 20, 5:00 pm EST

With nine trading days remaining in May, stocks are down about 3.5% for the month.  This follows a huge first four months from the year (up 3.9% in January, up 1.8% in February, up 3% in March and up 7.9% in April).

And for the coming week, there’s not much new information for markets to digest.  First quarter earnings season is nearly complete.  The economic data agenda for the week is very light.  And for the first time in a while, there is no expectation of incremental change in the U.S./China trade negotiations.

But this will likely still be the most important chart to watch this week …

 

The Chinese have not weakened the yuan beyond 7 (per dollar – which would be a breach of the white line) since the pre-Lehman days.

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Does China Control The Price Of Gold?

May 17, 5:00 pm EST

China continues to move their currency lower, as a way to offset some of the burden of tariffs (reducing the price of Chinese products in dollar terms).

And we’ve seen how the trajectory of the yuan is effecting Bitcoin.  Chinese citizens are trying to get their money out and doing so through Bitcoin.

Let’s take a look at how it is effecting the price of gold.

As you can see in the chart, the yuan and the price of gold have traded in a fairly close relationship.  

 

Of course, there are a lot of unconventional economic times incorporated in this chart (from 2006-present) — like a flight to safety in the financial crisis, which was bullish for gold. But is there anything behind the yuan – gold relationship?  It seems so.

As we know the Chinese has managed the value of their currency relative to the U.S. dollar for a long time (the currency of its biggest trading partner, the global reserve currency and the global currency of trade).  From 1996 to 2005, China pegged the currency at 8.28 to the dollar.  In 2005, they went to a managed float (to pacify WTO requirements and U.S. demands), where they allowed for a gradual strengthening of the yuan.

But it also seems clear that they have managed it to the value of gold. As they weaken the yuan, they reduce their buying power of gold (i.e. their ability to print yuan, sell it for dollars and buy gold – not to mention other commodities).  So manipulating the price of gold to preserve the yuan’s buying power is plausible.

If we think to the behavior of gold while China was running the currency peg from 1996 to 2005:  Gold was in a sideways range the entire time.  Only when they moved to a managed float in 2005, strengthening the yuan, did the price of gold finally break out of the sideways range of the prior decade (higher, along with the yuan). 

With the above in mind, as China continues to walk the yuan lower, we may find the price of gold making another run toward the $1,000 level. 

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Why ‘China Dumping Treasuries’ Headlines Aren’t Scary

May 16, 5:00 pm EST

There’s a lot of chatter about China offloading of U.S. Treasuries.

China is the largest foreign holder of Treasuries, with a stake of $1.1 trillion.  And the latest report from the U.S. Treasury showed China, as Reuters puts it, selling “the most U.S. Treasuries in nearly two-and-a-half years.”  Sounds scary.

The dark scenario of China dumping our treasuries is not a new one.  It has been talked about for a long time as existential threat.  Surely, an increase in tariffs and a tough negotiating position from the U.S. would set this into motion. Right?

Let’s take a closer look at this threat. 

 

Above is a snapshot of the recent TICs report.  You can see that China has sold over the past twelve months, $67 billion worth of Treasuries.  You can also see that any sign of “systematic selling” was short-lived (five months) last year.  It came to a halt when the sell-off in global stocks elevated the risks to global stability (i.e. when risk rises, they and everyone wants to own Treasuries — the safest parking spot for global capital).

You can also see that, over the past twelve months, the other biggest holder of U.S. Treasuries, Japan, was a net buyer (of $34 billion) – as was most of the rest of the world (to the tune of $250 billion).

The take away:  Even if China were to “dump” Treasuries there are plenty of buyers.  Don’t forget, the Bank of Japan is printing yen to buy assets (domestic and global). They could buy unlimited Treasuries.  The Fed can buy more Treasuries (they already own $2 trillion worth).

As we’ve discussed, China’s tool to fight tariffs isn’t the U.S. Treasury market, it’s their currency.  And devaluing the yuan increases the value of their dollar-based Treasury holdings (in yuan terms).  But any big one-off devaluation of the yuan would likely get China’s other global trading partners more visibly into the fight.

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Don’t Forget, BOJ Is Still Stoking Global Markets Through QE

May 15, 5:00 pm EST

The bounce for stocks continued today.  But global yields were broadly weak.

Why?  Is this a market that’s pricing in more global central bank easing (therefore lower rates, higher asset prices)?

It might appear that way.  Trump has been asking for a rate cut.  In fact, yesterday he tried to make the case for more QE (let’s assume he means ending the Fed’s balance sheet reduction program).  The fed funds futures market has been pricing in a rate cut for a while now — now looking for a 50% chance of a cut by September and a 75% chance of a cut by year end.

Additionally, the German 10-year yield hit the lowest level since 2016 — negative 10 basis points.  And the Japanese 10-year yield traded down to negative 5 basis points today (chart below).  

 

Now, as you can see, the 10-year in Japan has been back in negative yield territory all year — and sustainably, for the first time since 2016.

The last time rates were down here, the BOJ added some wrinkles in their QE plan.  Instead of targeting a size of asset purchases, they began targeting a zero yield on the Japanese government bond.  So, as long as the yield is positive in Japan, the Bank of Japan has the mandate to buy unlimited assets (print unlimited yen) to push the yield back to zero.  They already own half of the JGB market.  So, how can they influence yields higher from here?  They can sell JGB’s.  What might they do with those proceeds?  Buy global stocks?

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