Why is the market suddenly rallying like there is no tomorrow? After Monday’s 2% slump in the S&P investors never looked back and employed their firepower driving prices back up to and beyond the previous highs. Much like with Tesla that went vertical, probably as a function of the stock having been one of the most shorted and now being subject to the mother of all unwind operations, so many individual titles have shaken off any bearish sentiment, and some hit new all-time highs in the process.
One would have thought the world has enough problems on its plate. Apart from systematic flight cancellations to step-by-step border closures due to the ever more heightened concern that the coronavirus will spread further the rest of the planet doesn’t exactly inspire a scenario on the back of which financial rallies are made either. Despite Donald Trump’s self-adulation during his State of the Union address and his Senate acquittal overnight America is in a manufacturing recession of by now extended proportions.
And still, it’s risk-on! Not only stocks rise sharply, bond traders seem to have lost their appetite for the nominal risk-free, ie US Treasuries. 10-year yields, previously firmly on course to break the 1.50% threshold, have gained almost 15bp back up to 1.65%. As the risk markets are rallying, we might well see further dips in bond prices and the yield move back to the 1.75% vicinity. But does that make sense, or are we in the eye of the storm of a dead-cat bounce, both in equities and rates?
Jay Powell has said he would stay pat during 2020, manoeuvring a split not to aggravate Trump and regaining some lost credibility. It might even have worked, had there not been the unforeseen even of a potentially global epidemic. As mentioned yesterday, China’s growth numbers have become an illusion on the back of large swaths of the country grinding to a literal halt. And last I looked China was carrying approx. 40% of global growth, ie we are forced to apply discounts to the world’s economy as a whole.
To be sure, Beijing will not sit still. Heaven and earth are being moved to get a grip on the situation, which includes a massive monetary operation to re-inflate what is currently deflating. This kind of behaviour will not stop at China’s borders. Thailand and other countries have already taken action to mimic the PBoC’s actions, albeit on a much smaller scale. More of this will be required and coming, and Europe and America will not be able to shirk building its own defences.
The White House will have a close eye on the domestic macro data going into the real election campaign. Trump & Co simply can neither risk any derogation of their narrative that the economy is strong nor have the stock market go into a lull over the coming few months. With manufacturing being weak, oil prices rock-bottom, the trade agreement in peril due to the extraordinary circumstances, and inflation going nowhere there is every reason to consider accommodation as a hand-holding exercise.
If I was this betting man, then my money would not be on a continuing pat behaviour of the Fed. Watch carefully when the first drafts of headwind will be blowing, and they almost certainly will. Do you think Trump will stand idly by and not arm-twist Powell to the bone? It might not have to come to it, as the Fed chair has been shaken quite a bit in the wake of his disastrous calls through the end of 2018. He is likely to want to see himself and whatever is left of his legacy to be on the safe side.
So, how many cuts, you reckon? I for my part think two is the minimum. And who knows, there might be more in the offing down the line. As the PBoC is flooding China’s system, what are the chances of the Fed not seeing the need to add a little excess liquidity of its own? What would we call this? Not-QE4 again…? 😉 I guess the truth will rather be to call it QE5, as QE4 has been in full swing since the freeze in money markets from October last year.
But there is the issue of a yield curve inversion, isn’t there? Sure, and we might have been confronted with such harbinger of economic decline already, or expected to see it coming later this year, had Powell not chosen to support the short end so vigorously that we are still commanding a 20bp positively sloping curve in the 2/10-year differential, as I lined out in a
post end of last year.
What does all this mean for rates? It means there is no reason whatsoever for 10 years to move up to 2%. Rather, any anticipated Fed action will suppress yield levels again. The 10-year is in for further decline post this dead-cat bounce, maybe breaking the 1.50% mark, testing the 2016 low of 1.32%, and potentially giving it a run for the 1% target. It would encompass a dream scenario for Trump, and when hasn’t he got his way?
Any form of yield depression is a god-sent for what he wants. The economy will have a fall-back and provide sufficient back-wind for re-election. There will be even lower mortgage rates he will deliver to his electorate. Treasury refinancing costs will become more minuscule which is the foundation for bigger deficits yet, enabling him to both serve a second tax cut on a silver platter and realise the infrastructure program he owes the nation and he re-emphasised in his SoU speech.
