It seems like the entire week has been inundated with Fed talk, and that’s probably fine as by this time next week we will be kicking off earnings season, and I fully expect the fun stuff (bottom-up company results) to drive markets and media air time for the three or four weeks that follow. But until then, it has been all Fed, all the time, and Chairman Powell’s two days of testimony this week helped to drive a very Fed-heavy week in the news cycle.
In this week’s Dividend Cafe we really do give you the bottom line on the Fed, the future of interest rates, a sober assessment of recession, the reality of the tax cuts, and a nice play-by-play of the battle between stocks and bonds. It is chart-filled for those of you who like pictures, and ready for your digestion. Jump on in to this week’s Dividend Cafe …
Will the Fed Still Cut?
As of press time, the fed funds futures market is now pricing a 100% chance of a quarter-point rate cut in July, with a 33% chance that there will be a half-point cut. The inverted yield curve is not going to be resolved by the long end going higher any time soon, so the short end must come lower. The stunning 224,000 new jobs created in June added fuel to the fire of those saying the economy does not need a rate cut (hard to argue). But ultimately, in the face of impressive job growth and wage growth, one has to remember that the Fed really believes in their inflation target, and they really believe they are failing to achieve it (which calls for easier policy, not tighter).
That the 3-month to 10-year Treasury has been inverted this long now, but the 2-year to 10-year has not, is a pretty compelling call for the Fed to cut (and to many analysts, reason to believe a recession will still be averted). I am more interested in what they will do than what they ought to do, and I believe a quarter-point cut is going to happen, and a half point is not. But I am merely following what the futures market is telling me …
But Is a Recession Coming?
What is fascinating about all of this is that the Fed is saying they need to cut rates because they are worried about economic weakness surfacing, and we know that many times historically (not all) Fed rate cuts have preceded the onset of a recession, and yet investors are just loving the news. I believe the answer to that paradox was squarely addressed here in Dividend Cafe a couple of weeks ago: Companies still enjoy a Cost of Capital that is lower than their Return on Invested Capital … And until that changes, investors like what is happening, and I will not see a recession on the horizon.
I am in the “one and done” camp – that the Fed will do this July cut (a quarter point, not half), and then sit. I am sure the second cut in September is possible (but not assured) – the market is assessing a 59% probability to such right now, but I would be shocked if they dare to go beyond a total of 50 basis points worth of cuts. I don’t much like the concept of an “insurance cut,” but for those pricing a 38% chance we will see three cuts by the end of the year, or a 17% chance we will see four, I would gently point out that in no way could that be called an “insurance cut.”
Any Progress In China Talks?
I would be surprised if resolution (or even progress) comes from quite some time. The talks have resumed, and that is really all we know at this time. In the meantime, supply chains are moving out of China, and that is likely to continue happening until there is a resolution here.
Stocks vs. Bonds – Ready to Rumble
The collapse of longer-term bond yields in recent months, even as risk assets have made new highs, points to a tension in global markets that will continue to play out in the second half of 2019. Equities are responding to healthy corporate earnings, a Fed signaling a backstop for risk assets, and a healthy economy validated with full employment and robust wage growth. Bonds, though, we are told, are pointing to low growth and recessionary fears.
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