The Fed is back making major policy moves and you can see by the chart below, a 50bps move is a rarity and one that we haven’t seen since 2008. In most cases, the market was in the process of a cyclical correction like in 2000 and 2008.
The entirety of the curved crashed lower in yields after the announcement with long-term bonds reaching all-time lows. As you can see, the 30Yr bond yield dropped 35bps Friday morning to close at 1.288%. The Fed meets later this month and the Treasury market is telling us that there is a high probability of another 50bps rate-cut as T-Bill yields are trading 50-60bps below the 1-1.25% Fed Funds range. There is even a small probability that the 10Yr yields 0.0% by December. The Treasury curve is warning that the economy will contract in 2020 and that equity prices are likely to greatly suffer.
In another warning sign, credit spreads on high-yield bonds started to widen this week which we have not seen since December of 2018. As you can see, they can go much wider.
There has also been a migration to issuers that are below investment grade over the last 10 years which means a sustained move higher in credit spreads will be highly problematic for these issuers.
Let’s not forget about consumer debt which has largely been solid as the jobs market is robust. However, the consumer has taken on increasing levels of debt as interest rates have continued to fall over the last several years. A spike in the unemployment rate would bring another level of pain that we have not seen since the housing crisis.
So, all of these issues have been brewing over the past few weeks as the global supply chain is sputtering amid an outbreak of a highly contagious coronavirus. Hopefully, the warm weather will curtail the outbreak but it looks as though the number of cases domestically is just beginning.
From an investing standpoint, we are flying blind until companies disclose how the supply chain disruption is affecting their ability to generate revenues. We could be in for some ugly earnings reports in Q2. For now, the charts are providing some clarity in direction as it looks like we are in the early stages of a larger correction. A break of 2,850 (pink line) would kick-off another wave of selling that could re-test the December 2018 low. Perhaps, another wave of selling will guarantee 50bps from the Fed later this month.
Chart of the Week!
Economic & Central Banking Snippets
- The latest jobs report was unabashedly strong. U.S. employers added an average of 243,000 jobs in February, January and December—the best three-month stretch for job creation since the summer of 2016. Additionally, December’s figure was revised higher by 37,000 to a gain of 184,000 jobs, meaning that the US economy was in solid shape before the number of coronavirus cases nationally and internationally began to take off. (FT/WSJ)
- The unemployment rate eased back to 3.55% creating a 50-year low.
- Bank of Canada cut interest rates by 50 bps to 1.25%. In their statement they said “While Canada’s economy has been operating close to potential with inflation on target, the COVID-19 virus is a material negative shock to the Canadian and global outlooks, and monetary and fiscal authorities are responding.”
- The Federal Reserve executed an emergency half-percentage-point rate cut, reflecting fears the coronavirus epidemic is raising recession risks. The Fed reduced the federal-funds rate to a range between 1% and 1.25% in the first rate change in between scheduled Fed policy meetings since the 2008 financial crisis. (WSJ)
- The Caixin China manufacturing PMI fell to 40.3 in February from 51.1 in January, the steepest fall in the survey’s 16-year history and a worse contraction than analysts expected. The sector is suffering amid shutdowns, supply chain disruptions, staff shortages and travel restrictions. However, business confidence rose to a 5-year-high as firms expected a “V-shaped” recovery or output to rebound once restrictions are rolled back. The official PMI fell even lower to 35.7 in February, a record, from 50.0 in January. (Investopedia)
- The February ISM manufacturing index fell to 50.1 from 50.9 as new orders slipped slightly lower.
- The Reserve Bank of Australia cut rates by 25 bps to just .50% and left the door open for more. They of course cited the virus spread of the coronavirus and said “The uncertainty that it is creating is also likely to affect domestic spending. The board is prepared to ease monetary policy further to support the Australian economy.” (Boock Report)
- Malaysia’s central bank cut interest rates by 25 bps to 2.50% as expected.
- Italy closed all schools and universities to contain Europe’s largest outbreak, with more than 3,000 infections and 107 deaths. Fans were also banned from sporting events. (FT)
- United Airlines said it would cut domestic capacity by 10% and international flying by 20% as the spreading coronavirus depresses bookings. The carrier also said it is offering staff unpaid leaves of absence in April, the latest move by airlines to mitigate the shock caused by cascading travel restrictions and passenger concerns over flying. (FT)
- Virgin Atlantic refused to support Flybe after coronavirus halved its own bookings, according to a witness statement seen by the FT. The collapse of Europe’s largest regional airline puts about 2,400 jobs at risk. (FT)
- Campbell Soup said retailers are stocking up on its namesake product and other canned foods in response to the coronavirus epidemic, a boost to the beleaguered food maker’s sales. (WSJ)
- GE says the coronavirus outbreak will reduce its Q1 ’20 free cash flow by $300-$500 million. It also expects a hit of $200-$300 million to its operating profit. (Investopedia)
- Tesla is using older, slower control chips in its Model 3 vehicles due to supply chain issues in China. In a statement, Tesla China promised customers free hardware upgrades once production in the country gets back to normal. Angry buyers are threatening to take the company to court, according to Nikkei Asian Review. (Investopedia)
- General Motors will raise its spending on electric and autonomous vehicles to $20bn by 2025 after claiming a battery breakthrough that it says will give its cars longer range and faster recharging as well as making its new wave of vehicles profitable. Its new generation of electric vehicles will sit on a purpose-built platform called Ultium, giving them specifications ahead of industry leader Tesla in range, charging and acceleration — as well as making them profitable within the first range of vehicles to use the system. (FT)
That is all for now and thank you for being a subscriber!
Paul J. McCarthy, III
President – Kisco Capital