Times are a changing.

Stocks continue to be volatile as we head into the Easter and Passover break. Stocks fell amid concerns over corporate earnings and policy changes. The one policy that won’t concern stocks but may have cause for concerns for bonds is the changing stance on inflation by the Fed. (I will talk about that later in The Rant.)

Today was really about disappointment in earnings. The economy is performing but there are pockets that are underwhelming. Health providers fell on concerns that Trump is rejigging healthcare in an attempt to get the costs down and provide Medicare to all Americans. Such a move could upend earnings models. Biotech slumped and tech rallied past its August record.  The day’s trading was very much a mixed bag.

Some of the earnings numbers were strong. Morgan Stanley was up but Bank NY Mellon was routed. PepsiCo hit an all time high and IBM slumped. The Nasdaq hit an all-time high and Qualcomm continued its surging rally.

Bonds on the day were, well, quiet, to say the least. Bonds were slightly weaker on the day and that reflects the mood as we head into the Easter and Passover break. However, within all the sluggishness pervading markets for the moment, an interesting anomaly is happening. Junk bond investors have started to invest in the triple B sector of the credit curve.

The gap between double B and triple B is now very close as triple B’s fell out of favour in 2018 and spreads have not fully retraced. For the junk investors, a portfolio that is less risky and offering a similar return has its appeal. This stance has led to greater issuance in the sector which accounts for roughly 50% of the $6tr corporate bond market. Triple B’s appeal is that there are more levers they can do compared to high yield.

Triple B companies are larger, can spin off assets, cut dividends and restructure if they need to lower debt.  To give an example of how the spreads have changed, Ford six months ago issued a three year at T+108, yielding 3.813%. In January, Ford issued at T+325 yielding 5.596%. Junk levels are not too dissimilar.

Data out of China was good with economic growth slowed to 6.6%, industrial output up 8.5% and retail sales up 8.7%. All exceeded analysts’ expectations. The U.S. trade deficit with China slumped and the overall trade deficit slumped 3.4% to $49.4 bio in February. The trade deficit with China fell by 28.2%.

The Rant

The stance on inflation within the Fed appears to be waning. A new approach towards inflation is looming. Previously, the Fed set a level for inflation and once that level was broken a tightening cycle would commence. And often, that cycle would commence pre-emptively. In other words, if the Fed thought that 2% was going to be broken and the economy needed to be cooled the tightening cycle would begin.

The theory is that the target inflation rate will now be an average. In other words, inflation will be allowed to overshoot a targeted level without the Fed responding with a tightening. Part of the reasoning boils down to the fact that the Fed is perplexed why inflation has not exceeded 2% for some time. This has dramatic implications for monetary policy and bond investing. The stance would allow inflation to surge for a period unchecked, allow the economy to grow at a more rapid rate, and lower unemployment (possibly).

This is great news for Trump and vindicates his stance.

The risks are that a policy that keeps rates lower for longer will spawn speculative bubbles and excess leverage and that is a risk the Fed has to weigh. The move towards a new policy on inflation reflects the fact that monetary policy is not working in the current environment. Price pressures are muted and bond rates are benign. And the economy is growing despite all the warning flags that in the past would have resulted in further hikes in cash rates.

If inflation is too low as it now, the Fed has little ability to stimulate the economy with rate cuts. The Fed, under the policy under discussion, would allow an overshoot and an undershoot to average the 2% inflation rate. First though, the Fed has to get inflation to the target level of 2% if it is to be believed that it can manage the economy.

Powell has raised the possibility that this change could be adopted when it (the Fed) concludes its policy review in the first half of 2020. The change in policy is also being supported by former Fed Chair Janet Yellen. Chicago Fed President Charles Evans has also thrown his support publicly for the changing or rather the adoption of a new strategy towards inflation.

Market Recap.

Equities: The S&P 500 fell -0.23% and the Dow was flat down 0.01%.  The Vix closed at 12.60 while the Stoxx Europe 600 Index rose 0.1%.

Currencies: The Bloomberg Dollar index fell about 0.1% and the pound fell 0.05%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.594% while the 2-year is trading at 2.404% and the 30-year is at 2.994%. The U.S. curve closed on the day with the following closes 2/10 at 19.2 bp, 2/30 at 59 bp and the 10/30 closed at 39.8bp. The U.S. 5-year closed at 2.404% and the 2/5 spread is now 0.10 bp. The ten-year bund closed at 0.082% and the British gilt closed at 1.236% while the 10-year yen gilt is trading -0.007%. The bond market appears to be now factoring in no change for 2019 and a cut in January 2020.

Commodities: WTI fell by 0.1% and gold fell 0.1% while copper rose 0.9%.

Bitcoin is trading around $5,230.

Aussie Market Today.

Expect a quiet day today for stocks. There may be some selling pressure as we head into the extended break.

Bonds should see some selling on the day.  And the extended break should mean some squaring and covering of trades. Given the possibility of thin markets next week, it is unlikely that positions will be built.  This probably means some selling that probably will extend into next week as well. Credit remains bid and that demand looks set to continue.