Stocks And Bonds Diverge
It wasn’t that long ago the markets anticipated a substantial economic slowdown. The 20% or so plunge in equities was coupled with a sizable drop in Treasury Bond Yields.
Something odd is going on. Most key equity indexes are approaching all-time highs. Bonds yields, on the other hand, are breaking to new lows.
Inflation, as measured by Consumer Price Index, is now running at a 1.5% annual rate. (https://www.bls.gov/cpi/).
The rest of the economic news was disappointing, especially the surprisingly weak employment numbers. (https://www.cnbc.com/2019/03/08/nonfarm-payrolls-february-2019.html).
The Atlanta Fed now forecasts first quarter economic growth of just 0.2%. (https://www.zerohedge.com/news/2019-03-11/gdp-crash-atlanta-fed-sees-q1-gdp-tumbling-just-02).
Stranger still, DEBT of all forms is everywhere. The National Debt has crossed $22 Trillion with the Budget Deficit now exceeding $1 Trillion annually. Interest expense alone on this debt is projected to come close to $600 Billion this year. (https://www.zerohedge.com/news/2019-03-05/us-budget-deficit-soars-77-interest-expense-hits-record-high).
Add to this, student loan debt, which now tops $1.5 Trillion, and record auto loan debt. Delinquencies of all forms are rising, yet loan interest rates continue to hover at 2% domestically and 0% in Europe and Japan.
Bonds Of Every Type Make New Highs
The Federal Reserve has put any plan for raising interest rates this year on hold, pending economic data. A more likely scenario now is, the next adjustment will be to REDUCE, not raise rates. The Five Year Treasury yields LESS than the benchmark Federal Funds rate, closing at 2.39% last Friday. Arguably, monetary policy may STILL be too tight.
A slide show of the various types of bonds and interest rate sensitive securities is below. A few of the takeaways are as follows:
- US Treasury yields are now LOWER than they stood as markets cascaded into their Christmas Eve Lows. The Ten Year Treasury yield closed Friday at 2.59%. The longer 30 Year Treasury closed at 3.02%, a few basis points above ITS lows.
- Utilities, which are dividend yield plays, have made all-time new highs, despite the bankruptcy of Pacific Gas and Electric.
- Corporate bonds, both High Yield and Investment Grade, are also trading at all time highs. The market is assigning almost no premium to prospective credit risk. That too, is odd, if economic weakness is the factor keeping yields low.
- High Yield Bonds appear to be tracing out a Massive 7 Point Reverse Wave Pattern. The indication would be the formation of a Major Long Term Top.
The Federal Reserve’s policy, known as Quantitative Easing (QE) commenced in 2009. Under QE, the Federal Reserve purchased nearly $4 Trillion of Treasury Debt and Mortgage Backed Securities to inject greater liquidity into the financial system. The Benchmark interest rate, known as Fed Funds was lowered to zero and kept there.
During the tenure of Chairman Jerome Powell, the Federal Reserve has attempted to delicately unwind its prior easing. The Fed Funds rate was raised 4 times to its current target of 2.25% – 2.5%. Originally, Powell had forecast several more increases, but market re-action was decidedly negative.
Since then, the Federal Reserve has put any further rate increases off indefinitely. In addition, the Fed’s plans to reduce its massive balance sheet have also been substantially cut back.
After nearly a decade of substantial intervention, Powell has repeatedly reiterated that the Fed will be “patient”. The Fed is currently not practicing QE, and it has abandoned Quantitative Tightening (QT). All that remains is Quantitative Patience.
If history is any guide, the Federal Reserve will be Very Patient in raising rates, but not nearly so much when lowering rates.
Are Central Banks Panicking?
By comparison to the world’s other major Central Banks, the Federal Reserve is downright restrictive. The Bank of Japan and European Central Bank (ECB) still set NEGATIVE benchmark rates.
The Bank of Japan, which targets a 0% 10 year bond is even considering FURTHER easing. (https://www.zerohedge.com/news/2019-03-14/boj-policy-announcement-preview). The ECB has put off any interest rate increases indefinitely and sliced its growth and inflation forecasts for the region. (https://www.cnbc.com/2019/03/08/ecb-new-stimulus-may-not-be-enough-to-boost-euro-zone.html).
Among the non-US Major Central Banks, only the Bank of England and People’s Bank of China set a positive benchmark rate. (https://www.exchangerates.org.uk/news/24709/central-bank-rates-watch-interest-rates-on-hold-for-h1-2019-.html).
Yields across the planet are falling to new lows as the Slide Show below illustrates. While world equity markets appear to be floating on a sea of liquidity, bond yields continue to sink.
The Day of Reckoning May NOT Be Imminent
It’s tempting to conclude that the weakness in Bond yields will spill over into stocks in the near future. It MAY NOT. This dichotomy could very well persist for a while. The charts are still consistent with an extended move HIGHER in the major equity markets. “Dow 30K?, Yes, but” (https://markonomics101.com/2019/03/04/dow-30k-yes-but/). “Chipmakers Poised To Lead Nasdaq Higher”. (https://markonomics101.com/2019/02/06/chipmakers-poised-to-lead-nasdaq-higher-chart-of-the-day-13/).
For the time being, the charts are telling us something that the financial media is not. Go with the charts!
Be Informed, Not Misled!