The S&P 500 ended up unchanged on the week as it consolidates before the Fed on Wednesday.
The Fed has reversed course over the last year as trade tensions have flipped the Fed into accommodative territory and the market now expects rate cuts. The chart below illustrates the dramatic shift in expectations after Fed Governor Bullard let the cat out of the bag earlier this month with dovish commentary during an interview. Indeed, if the Fed cuts rates on Wednesday, the stock market remains the master it is feeding….but you probably knew that already.
Unfortunately, rate cuts typically precede recessions but we have to wait until next week to see what happens next. The inversion in the yield curve also screams of a slowdown coming (see more below) inside of two years – maybe near the 2020 election. However, in no time in history has the Fed held rates this low and maintained a balance sheet this big prior to a recession. Could this act as some kind of buffer for the stock market if we do hit recession? My initial thought is no as inertia has its own set of rules but we are in unchartered territory with the Fed’s policies over the last 10 years so I am willing to be patient and open minded. If the Fed delivers next week with a rate cut and the S&P takes out its previous high then it will be a good summer for the stock market.
What could throw cold water on the Fed afterparty? Inflation. If we see inflation spike next year (pick a reason) then the Fed would be forced to raise rates and then the bull market would end with one big hangover.
Chart of the Week!
“The term spread or the difference between long-term and short-term interest rates is a strikingly accurate predictor of future economic activity”, Michael D. Bauer and Thomas M. Mertens found in a 2018 Federal Reserve research paper, adding that “every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve”.
Economic & Central Banking Snippets
- The CPI report released this week showed that inflation remains muted. Both the headline and the core CPI figures came in below the median forecasts. The chart below does a nice job of showing what drives the internals to the headline number of 2%. Note that rent or housing is the largest component.
- In May, headline PPI (Producer Price Index), core PPI and core PPI ex trade were all in line with expectations. The core rate was up 2.3% y/o/y as was the core rate ex trade. The headline y/o/y increase was 1.8%. (Boock Report)
- Chinese industrial production in May rose 5% y/o/y, below the estimate of 5.4% and down from 5.4% in April which is the slowest since 2002.
- UK GDP in April fell .4% from March, well worse than the estimate of down .1%. Manufacturing production in particular plunged by 3.9% m/o/m, more than double the forecast of down 1.4%. That is the biggest monthly decline since 2002. GDP growth for the 3 months ended April was higher by .3% vs the estimate of up .5%. (Block Report)
- Japan’s GDP grew by 2.2% in Q1 which could increase the likelihood of a planned consumption tax later in the year. The positive reading was due to improvements in capital spending, the Cabinet Office figures showed.
- Turkey’s credit rating has been cut deeper into junk territory by Moody’s Investors Services, with the agency citing its high reliance on external capital flows and rising risk of government default as reasons for the downgrade. Moody’s cut the country’s long-term debt rating by one notch to B1 from Baa3 and maintained a negative outlook. The inability of political authorities to implement a plan to support the economy remains a key concern. “Turkey is structurally highly reliant on external capital flows, and Moody’s confidence in its ability to continue to attract the large sums needed each year to repay debt and sustain growth is waning”, the agency said.
- Chinese exporters are dodging U.S. tariffs with fake labels. “Vietnam said that it found dozens of fake product-origin certificates and illegal transfers by companies trying to sidestep U.S. tariffs on everything from agriculture to textiles and steel. The statement…adds to concerns that some Chinese exporters are illegally rerouting orders after Trump imposed tariffs,”. (Bloomberg).
- Two of Europe’s biggest tech titans, Nokia and Ericsson, have started drawing up emergency plans to move some of their most sensitive operations out of China and split up their supply chains to counter increasing national security concerns. The drastic steps would include changes to their corporate structures, including setting up separate units in the Eastern and Western Hemispheres, in a bid to protect themselves against the escalating global trade war. Both companies make equipment used to run 5G networks. (Seeking Alpha)
- TOP OF THE MARKET ALERT: Lilium, a Munich-based flying taxi start-up, plans to create “hundreds of high-end software engineering roles” at its new London hub over the next five years. The announcement comes just weeks after Lilium revealed its all-electric, five-seater prototype taxi, which takes off and lands vertically. Its flying taxis will be able to ferry passengers from London to Manchester in under an hour, according to the company’s website. “We are one of very few companies in our sector that wants to both produce air taxis and then operate them day-to-day,” said Daniel Wiegand, chief executive. Lilium, founded in 2015, has also appointed three new senior executives with the goal of making the group’s services “fully operational in several cities around the world by 2025”. (FT)
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Paul J. McCarthy, III
President – Kisco Capital