Have We Reached Peak Turmoil?

Dec 21, 2018
US Capital Building

Treasuries are rallying again this morning after another day of turmoil in D.C.. The on-again, off-again government shutdown appears to be on as the president reversed course and decided he did need $5 billion in border wall funding in the stop-gap spending bill. The Republican House obliged by  passing such a bill yesterday, but the Senate, which passed its own spending bill on Wednesday but without wall money, is not likely to get the 60 votes to pass the House bill so a midnight shutdown looms. While a short, partial government shutdown is not impactful to economic results it reflects the ongoing dysfunction in D.C..  Add in the sudden resignation announcement of Secretary of Defense Mattis and we may have reached peak turmoil to date.  All of that has pushed data to the sideline but the final estimate of third  quarter GDP (3.4%) and November durable goods ex-transports (-0.3%) both missed estimates which is also contributing to the Treasury bid. November personal income and spending numbers are later this morning and will be important tells on the health of the consumer. Expectations are for a slight retracement from October but both are still expected to print 0.3% MoM gains which would be respectable but off the 0.4% annual average.  Resistance levels we’re watching are 2.75% for the 10-year (currently 2.78%) and 2.96% on the 30-year (currently 3.02%). Any combination of political and/or economic angst that pushes yields through those levels could lead to even more rallies.


  Economic News


We’ve all heard, or lived through, the Taper Tantrum, when in May 2013 then Fed Chair Ben Bernanke committed an unforced error and hinted that quantitative easing could soon end. That off-the-cuff remark sent Treasury prices spiraling lower on the thought the Fed’s bond-buying program was finished. The 10-year went from a 1.63% to 3.00% in the space of three months. Eventually cooler heads prevailed, the QE program wasn’t abruptly axed, and with GDP dipping from a 3+% rate in early 2013 to –1.0% in the first quarter of 2014 bonds found a bid with the 10-year note falling back to 1.64% in January 2015. Quite the roundtrip.


We note that bit of history because with the reaction in equity markets to the Fed’s policy decisions on Wednesday, it struck us as something akin to the Taper Tantrum but this time bonds were the beneficiaries of the kicking and screaming by equity traders.  Stocks have certainly been spooked since early October that something is amiss in the global growth story and perhaps they felt the Fed would ride to their rescue with a pause in the hiking cycle and a more forceful declaration that they will be easing in 2019 if equity and global growth weakness continues.


To us, however, that seemed a foolish expectation. We mentioned in earlier notes that this is nothing if not a gradualist Fed. To expect them to cut their 2019 rate-hiking forecast from three to one, or none, was just unrealistic, especially with fourth quarter GDP expected to print near 3.00%. The fact they cut their 2019 forecast to two hikes, and lowered their long-run estimate of fed funds to 2.75% from 3.00% struck us as a gradual and realistic move given the still positive domestic economic growth, admittedly tempered by the gathering global concerns.


One point we can quibble with the Fed is the forecasted hike in 2020 which, if preceded by two in 2019, clearly pushes the fed funds rate into restrictive territory.  Given the gathering global headwinds, the equity meltdown, and increasing domestic political and economic uncertainty, and the falling inflation expectations, we think that hike is never going to happen and the Wednesday forecast could have easily reflected that.


As for 2019, we have no doubt we’ll see some softening in economic fundamentals, it’s just a matter of how much and how fast. Given the extent and breadth of wealth destruction in the fourth quarter the softening could come faster and deeper than the Fed expects. That’s why we feel we’re close to the end of this tightening cycle. If the economic numbers do soften you can expect the March forecast will be downgraded from two hikes to one or none. Remember too that beginning in January, every Fed meeting will have a press conference. Thus, Chair Powell will have the opportunity to address the evolution of Fed thinking on a more timely basis than the quarterly press conferences of yore. We think this will provide a more timely response from the Fed to the market. 


Just as the bond market overreacted to the first hints of QE tapering, and corrected the ill-advised selling within months, so too we think the stock selling from an inadequately dovish Fed can correct in due time, especially if the economic numbers don’t soon start displaying the expected dramatic slowing.


In any event, looking at past tightening cycles nearing a conclusion, intermediate to long-term bonds tend to sniff out the pause and/or end of tightening well before the Fed actually declares such. That seems to be the case here too. The 10-year peaked at 3.24% on November 8th and has shed nearly 50bps in the subsequent equity selling and increased concern over global growth. So even though the Fed is still signaling two hikes in 2019, the market, both in futures and in long-term yields, is reflecting a growing sense that the pause is upon us. This is a point we’ve made in recent seminars, but while the long-end has already rallied 50bps, in past cycles the rallies continue well into the easing cycle so there’s still time to capture the gains via duration purchases with the expectation that prices will rise when the pause and easing cycle clearly commences.



Market Update  Oils Drop Below $50 Spells More Trouble for Stocks

Before the latest downdraft in stock prices, which many investors are pinning on an inadequately dovish Fed, oil was a pretty good indicator of stock market direction. The graph illustrates the price of West Texas Intermediate Oil and the S&P 500 Index. Oil’s break below $50/barrel could indicate the S&P 500 and oil are headed to 2016 support levels. That corresponds to the low $40’s for oil and around 2150 on the S&P 500. That’s another 13% down from here. So, unless you’re inclined to try and catch falling knives it might pay to wait.


Oils Drop Below $50 Spells More Trouble for Stocks



Agency Indications  Market Rates


Market Rates



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