Are They Driving Too Fast?! – Notes for Week Ended 6/15

Following the most recent Fed rate hike decision last week, Fed Chairman Jay Powell went on record suggesting it is a puzzle why long bond yields are staying so stubbornly low. Yet for those well researched in the dynamics of the bond market and the crowd-based wisdom it can convey, the message is clear: the current rate-hiking pace of the Fed is believed to be unsustainable by the bond market and it will slow down economic growth if not made more glacial than presently being communicated. At present, short rates are rising more swiftly than the long-end of the curve is adjusting in recognition of faster economic growth; should the yield curve invert (meaning long rates are less than short dated ones), it signals a serious policy mistake has been committed and an economic recession should be anticipated.

The week ending June 15 was relatively light on economic data, and heavy on big macro and headline grabbing events. There were no shortage of punches thrown at the market. Aside from the Fed meeting, which resulted in making good on another well-telegraphed interest rate hike (caught no one off guard), there was also the much anticipated summit between North Koreas Kim Jong Un and President Trump; as well as signal from the 2nd most important central bank, the ECB as to whether it will conclude its program of quantitative easing and begin the task of balance sheet contraction. On the former topic, the summit was light on specifics but symbolizes a show of de-escalation of sometimes hostile tension between N Korea and the rest of the world (namely the US). That development is certainly not a market negative. On the ECB, a change of course and path toward policy normalization brings back memories of the Taper Tantrum experienced when the same notion was floated in the US several years back. Yet in a world where the US continues to normalize policy and so many others remain accommodative, the gap between world policy continues to stretch. Things that stretch too far usually break, and right now the stretch is creating financial stress for emerging markets due to the strengthening implications for US dollar denominated debt and trade. So in this case, the broad market may applaud actions that relatively tighten non-US monetary policies and begin to narrow or at least stabilize the perceived gap. Still, tariff and trade-war worries received another douse of fuel as the Trump administration announced it would move forward with tariffs on select Chinese imports.

All told, the events and data (which continues to suggest the economy in the US is chugging nicely in 2Q) yielded a market result that was roughly flat for the week ended June 15. As a matter of fact, it was actually the narrowest weekly trading range for the markets for the entire year. Each of the major headline events of concern to investors leading into the week went largely as expected and in-line with consensus; thus there were no big surprises for the markets to digest. As far as the US yield curve goes and the flattening it is experiencing, it is important to note that the curve remains upward sloping. While worth monitoring closely, the important distinction that it remains positive sloping would suggest time remains in the current cycle. We remain constructive on the economy at the moment, but believe choppy trade through the summer months and US midterm elections is probable.

Posted in Blog Post.