Last week the Fed cuts interest rates for the first time since the GFC a decade ago and the market’s response was pretty interesting. After referencing the 1995/96 one-and-done cut that prolonged the 90’s expansion all summer, I think they were hoping that they could get away with one cut as “insurance” that would ease concerns and buy them time. Well, Jay Powell actually managed to tighten financial conditions at the same time as cutting interest rates. The dollar rallied and corporate spreads widened after he made comments about this being a “mid-cycle adjustment.” That’s literally the exact opposite of what the Fed wants to see after “easing” monetary policy and it’s once again the market’s way of telling the Fed that they still don’t get it.
President Trump followed it up less than 24 hours later by tweeting that the US will be increasing tariffs on another 10% on Chinese goods. He’s been harping on the Fed all year to loosen monetary conditions and probably announced further measures in an attempt to force the Fed’s hand. His pushing on the Fed and threatening to remove Powell as Chairman is threatening the Fed’s independence so I’m sure they have resisted his goading just to appear independent. It’s a tricky game they’re playing because the markets have been calling for rate cuts going back to last fall. Longer-term yields have dropped even more following last week’s botched cut, putting the Fed even further behind the curve. Even with last’s week’s cut, I still think they need to cut another 0.75% at least just to get to a neutral policy.
Another way to track whether short-term interest rates are loose or restrictive is to watch the Fed Funds Rate relative to the 2-year Treasury Note yield. When the 2-year drops below Fed Funds and continues to slide, it usually means the Fed is behind the curve and a rate cutting cycle has begun.
It’s important to understand that monetary policy changes, like interest rate increases and cuts, typically have about an 18 month lag before they start to show an effect on the economy. It’s like trying to turn around an oil tanker. You can’t just stop on a dime. It makes a big, long arc as it turns around. The slowdown we’re seeing globally this year is because the Fed lifted rates too far the previous two years. It’s not that they shouldn’t have raised rates, it’s just a cyclical effect that higher rates eventually slow things down when economies are over-indebted. This means that the economy is basically on a set course unless we see drastic policy changes on the fiscal side which is easier said than done. I ultimately think we will but it’s unlikely before the 2020 election, in my opinion.
The stock market is at a pretty critical juncture right here and I think August’s close on the S&P 500 is going to be an important tell. Below is the longer-term momentum structure that I’ve shown a few times now. Despite rallying to new highs this year, momentum continues to diverge and actually failed to regain the broken support structure (horizontal blue line in the bottom pane). The past 20 months have created a large triangle and should lead to a pretty big move in the direction it breaks. The S&P 500 needs to close August above the 2900-2910 area to hold the upward sloping trend line (green line) and also remain positive on the year-over-year rate of change. A close below 2900 will likely lead to a drop to test the zero line in the low 2600’s – we’re currently around 2880 as of this post.
If things break lower, my longer-term target still remains the 2125-2175 area as strong support—this is where I will get very aggressive with buying stocks in general but I’m sure I would be buying individual names the whole way down once each one looks attractive on its own. I’m not ruling out the possibility that the market holds this trend and pushes to new highs but given what I’m seeing across other markets, it’s definitely a low probability scenario.
Bond yields still look like they want to press their 2016 lows:
After peaking in January 2018 with international stocks, copper hasn’t participated in the “reflation” rally this year at all and has just broken a key support line. Low $2’s look to be coming:
Gold continues to climb after breaking out from a 6 year base, despite the strength in the dollar. And oil looks like it’s starting to break lower with emerging markets as well.
Europe and Asia are experiencing a pretty severe slowdown right now and markets are screaming that something just isn’t right. I ultimately think we’re going to get a lot of fiscal stimulus in both the US and Europe and this will eventually be very positive for stocks. I’m also quite positive on copper in the long run given the electrification of everything going on right now. It’s just a waiting game at this point where you keep your powder dry and wait for the right opportunities to be created (i.e. lower prices) or for the macro environment to begin to improve before going overweight on your exposure. Breadth is still holding up quite well but we’re in a news driven environment that can change things rather quickly. Let’s see how August plays out for now.
Thanks for following!
-Nick