If that headline sounds like relief to your ears, read further. While there are no clear signs out of the Fed yet (other than increasingly dovish talk), new data is showing that the Fed may cut rates in 2019. The forward spread shows that traders are anticipating a rate cut at the beginning of the year. Two-year Treasuries have seen their yields slip below one-years’. This is the first time this has happened since 2008. According to a market strategist at Pimco, “This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate”.
FINSUM: We don’t think the Fed will cut in the first quarter unless something more drastic happens, but we are quite sure they won’t hike.
For the last few weeks, the Fed looked like an out of touch ivory tower central bank committed to driving the US economy into a recession through relentless rate hikes (or at least that was the anxious view). However, the Fed has finally made an announcement which gave investors some calm. The head of the NY Fed commented that being “data dependent” meant listening to markets too, not just the economy. He also contextualized the language from the last Fed meeting, softening its impact. The market jumped immediately on the news.
FINSUM: Too bad it isn’t Jerome Powell making the comments. That said, the Fed must be starting to get nervous that we are close to a bear market.
There has been a large segment of money managers and investors that have taken a bullish stance against Treasuries. With rates rising and the economy performing well, it stood to reason that yields would keep on rising. However, after a couple of months of brutal stock volatility and worries over a trade war and growth, investors are finally shedding those bearish short positions. The stance was one of the most popular of the year, but the volume of bearish positions has shrunk by two-thirds since from the record it reached in late September.
FINSUM: The ten-year yield now looks more likely to fall than rise given the longer-term economic outlook and trouble in stocks.
There is a lot going against equities right now. A trade war, rising rates, a weaker 2019 earnings outlook, a fading tax effect, and high valuations. There is one more to add to the list, and it could end up being the worst of all—stocks are now yielding significantly less than short-term bonds. Two-year Treasuries are yielding 2.82% while the S&P 500 is yielding just 1.9%. Yields better than bonds had been an incentive for investors to put money in stocks for years, a phenomenon called “TINA”, or “there is no alternative”.
FINSUM: With all the volatility and headwinds facing equities, and relatively unattractive yields as well, it is hard to see what force is going to swoop in to help out stock indexes.
Pay attention, the yield curve just inverted. And we are not talking about some esoteric swap rate most have never heard of. Yesterday the spread between two-and five-year Treasuries fell below zero, the first major inversion of this bull market. The 2- and 10-year spread is the most typical benchmark for gauging an inversion, but the 2- and 5-year is significant. Yield curve inversions are one of the most accurate predictors of recession, with one preceding the previous several recessions.
FINSUM: One very important thing to remember is that it often takes many months (or years) for a recession to begin once a yield curve starts, so there is still plenty of room for the economy (and markets) to run.