Mixed messages could be the answer. Trump decided today that with the FOMC meeting today that it would be a good opportunity to tell the Fed that it should cut rates steeply. This announcement comes with a backdrop of one of the few performing economies.
Trump believes that a drastic rate cut is required and at the same time criticised the Fed for “incessantly lifting rates amid wonderfully low inflation”. At the same time, he praised China for adding great stimulus. Trump has urged a full point rate cut which was double what his economic adviser Larry Kudlow suggested.
What could go wrong? The economy in Trump’s view would take off like a rocket. And that’s probably where it all ends because once the rockets fuel runs out it crashes. The U.S. economy is not like China’s which is planned and mostly orderly.
Business is incentivised to do certain things to the benefit of the Country or region and works hand in glove with the government. Huawei is an example of business working with government that comes to mind.
For the U.S. economy, a significant rate cut as suggested by Trump does not necessarily mean much lower borrowing costs. The bond market would most likely sell. Bond investors certainly would be wary of the Fed and also of the borrowing task that the Treasury requires due to the large budget deficit. What could go wrong?
I will cede that to some extent Trump may have a point on inflation because inflation is something that the Fed has failed to ignite. Core inflation is now about 1.6% well below the target level of 2%.
The concerns should be towards leverage, as the amount of leverage now in the corporate sector will make the next recession deeper and probably a lot worse than expected. It’s not only an FOMC problem. It’s a problem in Sweden and it’s a problem for the ECB. And it’s also a problem for the central banks that simply confounds and dismays central bankers.
The bond market was a little bit whipsawed today. The ECI Case-Shiller Consumer Confidence new Home Sales was strong but the Chicago PMI (which some believe was leaked) was weak coming in at 52.6 vs 58.8. Bonds rallied and some believe that the Fed may cut which vindicates to some degree Trump’s call. Real money accounts were actively buying in the morning.
Traders continue to favour steepeners. The Treasury Department announced its refunding programme for the second quarter, and it appears as though the borrowing task will be much less than expected. The task is roughly $30 bio which is about half of what the market expected. Boeing issued $3.5 bio of bonds today despite the scrutiny it is under in relation to its 737 Max.
The S&P 500 had a mixed day. The FAANGS were pummelled as their results were below expectations with a combined loss of nearly $100 bio in market capitalisation. Alphabet had its worst day since 2012 on a revenue miss and fell 7.5%. Alphabet shed some $69 bio. Whilst Apple was up on a better than expected sales forecast in the after-hours market. Facebook was sold after another revenue miss. Equity markets were confused by Trump’s remarks. Volume on the exchanges was good with 7.22 bio shares being exchanged versus a 20-day average of 6.56 bio.
The big risk now for the market is the melt-up. This makes the S&P’s surge of 17.5% interesting especially as the Fed has a 27% chance of a recession in 2020. Commercial and industrial loan growth is $2.36 tr and corporate earnings are better than expected in that they are not as weak. Some 55% of stocks are trading above their 200-day moving average. Stocks look set to continue to rally.
Bond traders feel that the Fed won’t be raising rates any time soon and, despite Trump’s protests, is probably not going to ease anytime soon as well. Although the odds of a reduction are now around 65% up from 40% prior to the last read on inflation.
According to LPL Financial, of the 45 times the Fed has cut since 1950 only 12 came after a quarter where growth was 3% or more. Bond traders appear to be too bullish as the economy at worst is benign and so too the global economy. A trade deal with China would certainly be a massive boost for the U.S. economy. History suggests that there may be pain.
In 2016, we had the Brexit vote and that caused uncertainty for investments. However, by the third and fourth quarter of 2016, bond yields had started to spike higher and the Bloomberg Barclays U.S. Treasury Index fell a whopping 4.1% and the Fed hiked rates.
I am not suggesting that will happen this time but with reasonable economic growth globally, bonds are possibly a little ahead of the curve.
Equities: The S&P 500 rose 0.15% and the Dow rose 0.15%. The Vix closed at 13.12 while the Stoxx Europe 600 Index was flat.
Currencies: The Bloomberg Dollar Index fell 0.3% while the euro rose 0.3%. The pound rose 0.8% and the yen rose 0.2%.
Bonds: (as at 4.30pm). The ten-year is trading at 2.504%. The 2-year is trading at 2.266% and the 30-year is at 2.93%. The U.S. curve closed on the day with the following closes 2/10 at 23.4 bp, 2/30 at 66.1 bp and the 10/30 closed at 42.5 bp. The U.S. 5-year closed at 2.278%. The 2/5 spread is now 1 bp. The ten-year bund closed at 0.012% and the British gilt closed at 1.183%. The 10-year yen gilt is trading -0.031%.
Commodities: WTI rose 0.7% and gold rose 0.3%.
Bitcoin is trading around $5,254.
Aussie Market Today.
Equities look set to be more of the same. Expect a little bit of a rally as we head into financial year end. Politics, of course, will play a part and with the elections looming it’s hard to see stocks advancing too hard and especially so with Golden Week.
Bonds are likely to hold a bid tone until we get past the elections and the RBA Board meeting. The front end has factored in a rate cut and will certainly spit the dummy if a rate cut fails to eventuate on May 10.