“Stocks Eye Best Week of 2019 on ‘Powell Put’ Bets,” read the Friday Bloomberg headline. By the close of Friday trading, the S&P500 had posted a gain of 4.4% (“best week since November”). Also from Bloomberg: “Fed Watchers Say a July Rate Cut Is In Play, June Not Likely.” Markets now price in a 25% probability of a cut by the June 19th meeting, 86% by July 31st and 96% by September 18th. Markets a month ago saw only a 33% chance of a cut by the September meeting.
Ten-year Treasury yields declined four bps this week to 2.08%. German bund yields dropped another six bps this week to a record low negative 0.26%, with Swiss 10-year yields down three bps to negative 0.52%. Japanese JGB yields declined three bps to negative 0.12%. Some of the more spectacular yield moves have unfolded away from the typical safe havens. Spanish 10-year yields dropped 16 bps this week to a record low 0.55%, and Portuguese yields sank 19 bps to an all-time low 0.62%. Greek yields fell eight bps to 2.81%.
And if there is any doubt that market prices have completely detached from underlying fundamentals, look no further than Italy. Italian 10-year yields collapsed 31 bps this week to 2.36%. Spectacular panic buying across global bond markets.
June 4 – Wall Street Journal (Nick Timiraos): “Markets rallied Tuesday after Federal Reserve officials said they were closely monitoring the recent escalation in trade tensions and indicated they could respond to any economic deterioration by cutting interest rates. ‘We do not know how or when these trade issues will be resolved,’ Fed Chairman Jerome Powell said… ‘We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.’ Mr. Powell didn’t say whether he thought a rate cut would be needed. The comments show the Fed has ended a debate over whether its next move would be to raise or lower rates and is focusing now on whether and when to cut them.”
The Fed Chairman didn’t suggest – or so much as mention – a rate cut. Markets take “closely monitoring” as assurance that the FOMC learned its lesson back in December. A Thursday headline from the Wall Street Journal: “Fed Begins Debate on Whether to Cut Rate as Soon as June.” And Friday from CNBC: “It’s No Longer a Question of if the Fed Will Cut Interest Rates, But When.”
Assuming the market has this right, the Federal Reserve is preparing for additional monetary stimulus – perhaps in less than two weeks. This means the Fed would be cutting rates from already extremely low levels, with the unemployment rate at 3.6%, 3.1% y-o-y wage growth, 10-year bond yields just above 2.0%, y-o-y CPI up 2.0% (core up 2.1% y-o-y), along with highly speculative stock prices posting strong gains for the year and the S&P500 less than 3% away from all-time record highs. (more…)