The F-e-d did what??
On Wednesday the Federal Reserve did exactly what was expected when they cut the federal funds rate by 25 basis points (one-quarter of a point). This now represents a half-point reduction in the last two meetings, bringing the Fed Funds rate back to a range of 1.75%-2% (and removing the two rate hikes they did in the fourth quarter of 2018). The market ended up the day +36 points in the Dow (at one point it was down 200 points), and at press time Thursday, it was up 100 points or so. The futures market is now only pricing in a 40% chance of one more rate hike in December, and a 60% chance of no action in December.
My comments in the immediate aftermath of the Fed announcement can be found here (from Fox Business).
More on the Fed below ...
The other three-letter word of the week: O-i-l
If it were not an FOMC week, the major story would surely have been the Iranian drone attack on Saudi oil fields over the weekend. The attack not only struck Saudi oil production and processing facilities. My belief is that the timing of this event strikes specifically at the removal of John Bolton from the administration, testing the President's resolve in the Middle East. Therefore, I see it far more as a geopolitical story than an economic one. Oil prices went up ~13%, reaching the ~$60 level (note: this is where oil was in July, and in May, etc.)
As of press time oil is sitting at $58.50. This cannot be considered an "emergency level" by any stretch. Status quo action in world energy markets.
A note for Elizabeth Warren
Now why do you think the biggest oil disruption on record had such a quiet effect on markets?
Well, perhaps it has something to do with this...
U.S. oil production is the key economic differential from the world of old. Any disruption matters, but the magnitude is far, far less when the U.S. is producing over 10 million barrels per day itself! The fracking revolution is a major economic story of the last decade, but it is the geopolitical story of the decade as well.
An angle to watch
If there is to be a sustained movement in oil prices, one question is what the impact may be on the dollar. The relationship between oil and the dollar is quite misunderstood, in that (as the chart below shows) it is often susceptible to a very high correlation, and often to a quite inversed correlation. It has been more positive than otherwise for a while, but this is useless predictively. It has been a while since I have written about this, though this brings me back to 2015-16 quite a bit ... What matters is the reason oil is moving in terms of anticipating the impact on the currency in which it is denominated. All things being equal, of course, the correlation should be negative, but all things are never, ever equal when it comes to oil.
It is worth noting that the dollar's move in the aftermath of the Saudi incident (and indeed, all global currency markets) was entirely stable.
Jerome Powell does not look like Mario Draghi
One can debate what Jay Powell is doing and not doing, but it is worth paying attention to what our friends across the pond are doing. The European Central Bank is now effectively paying banks to lend money (i.e., lending to banks at a lower cost than it pays them for deposits). So between negative yields to help monetize government debts, and an upside-down cost of capital for banks, it's fair to say Europe's central bank is all in to take monetary experimentation to new levels. What could go wrong?
Back to the Fed
What does the Fed do next? It would appear another rate cut by the end of the year is still in the cards but by no means guaranteed (futures market is now pricing slightly higher odds against it than for it).
In the most basic of formulations, the challenge the Fed has right now is that they are claiming to make monetary policy decisions out of an approach of "data dependence," while simultaneously talking about the need to cut rates for "risk management." The two are not really compatible, at least when the terms are defined in their most traditional senses. If "risk management" is the priority (i.e., being prepared for a slowdown from the trade war), one can argue they have not cut enough. And if "data dependence" is their driver, they likely should be sitting on their hands. "Business uncertainty" is not a data point. Slower global growth is not part of the dual mandate (full employment and sound money). My comments are not suggesting they are right or wrong, but rather that changing the criteria for what data drives you is the same thing as not being driven by data.
Why no celebration?
Why do we not see a significant amount of promise in the Fed actions around cutting rates? Because traditional monetary policy has little to offer when starting from a position of already such low-interest rates. If and when the economy does see a recession, it certainly seems likely that more asset purchases (QE) are in the cards. This, too, is likely ineffective, as it cannot create real credit growth if there is not a productive investment to tap such credit.
Short term the Fed seems continually willing to coddle risk assets. Long term, the true causes of dis-inflationary forces are either not understood, not appreciated, or both. This is not merely a statement about central bankers, but the media, the financial services industry, and the public-at-large.
I think the market will respond most favorably to current existing tariffs being removed (whereas "not escalating to new tariffs" is seemingly already priced in). But existing tariffs being removed is unlikely without a larger deal, and a larger deal doesn't seem to be on the table without major structural reforms, reforms that China doesn't seem ready to agree to. A "small deal" to de-escalate the trade war (certainly from the code red levels of early August) would be a good thing, and it may very well be the most likely at this point (and politically convenient). A large deal, though, would be a positive surprise to markets. Deputy trade negotiators have allegedly resumed conversations, with agricultural issues being the largest agenda item, and intellectual property protection being the other.
By the way ...
Who is the world's largest importer of oil?
Just sayin' ...
Pros and Cons, Assets and Liabilities, The Good and the Bad
Our present market call is for "balance" and "moderate, median exposure" (the more technical way of saying it for those who listened to a recent Dividend Cafe podcast our Investment Committee did on the subject is that we are in a "strategic" allocation weighting, client by client, devoid of "tactical tilts" that underweight or overweight equity) ... I would point to the following push/pull that helps rationalize that perspective:
Money is loose; monetary policy is accommodative. Yet the trade war is lingering, uncertain, and problematic.
Fiscal policy is pro-market, with significant corporate tax reductions and incentives for businesses to invest. Yet fiscal health is weak, plagued by excessive deficits and national debt.
The U.S. is relatively strong, with insatiable global desire for U.S. assets. Yet the strong dollar is real and has impacted earnings for our multi-national companies.
Liquidity is abundant, with credit flowing, demand high, and cost of capital low. Yet earnings projections are questionable, and slowing but previous momentum.
I could probably go on and on, but I think you get the idea ... Humility. Sobriety. Balance.
One of my favorite questions ever
"Why have treasuries backed up so much this last week or two?"
Treasury bond prices go up when yields drop, and treasury prices go down when yields increase. The 10-year dropped from 3.2% in October 2018 to 1.5% in August 2019, and yes, Treasury prices were on fire. In the last couple of weeks, the 10-year moved from 1.6% to 1.9%, and yes, Treasury prices have declined. So the question is, "why did that last move happen?"
The answer is because the first move happened. In other words, Treasuries sold off because they were deeply, and I mean deeply, over-bought. It was a crowded defensive trade, and when the time was right, a lot of that sideline money parked in Treasuries made its way back into equities. You have a stock market up nearly 2,000 points in the last few weeks and Treasuries down.
Because that is the zig and zag of markets, period, is it all a little quicker than normal as of late? Sure. But it isn't abnormal to see, and in fact, it is part of the daily reminder of why asset allocation matters for an investor.
Some dollar perspective
I am told we are to be frightened by the dollar's relative strength against world currencies, and I certainly acknowledge that (a) It has been a surprise how resilient the dollar has been, and (b) It is largely a result of the weakness of economic conditions in competing domiciles, and (c) It does impact short term the earnings of multi-national companies who do a lot of business overseas. But I also would note that for all the talk about dollar strength this year, the Russian Ruble, Japanese Yen, Canadian dollar, and Swiss Franc have all strengthened against the dollar. The Euro is the one to watch (down 3% against the dollar on the year), there are a lot more currencies the dollar has strengthened against than vice versa. But my point is that it has hardly been a late-2014 style dollar rally, and any attempt to aggressively seek a weaker dollar (as some have called for) would bring collateral consequences that we may not like much either.
Yes, do that!
Secretary Mnuchin has said that the Treasury is seriously considering issuing 50-year Treasury bonds. There will surely be some demand for such, and it represents an extraordinary benefit to the U.S. government at these rate levels. Extending the maturity profile of the U.S. debt would be a de-risking move for Treasury, and provides investors looking for deflationary hedges great opportunity. We will be watching this carefully. But it is a step in the direction of fiscal wisdom for the government, which is not something I utter in these pages often.
What is negative about being negative?
At the end of the day, in the simplest of terms: Banks get punished for making loans with negative interest rates. Credit is essential to economic growth. If credit is impacted by the distortion of negative yields, far from the idea of stimulating economic activity, it will dry up economic activity. As is the case with all enabling, a monetary policy hellbent on enabling reckless fiscal behavior from governments ends up doing more damage than the damage it sought to alleviate, to begin with.
My economic lesson for the week
When we pay a country in U.S. dollars for the products we buy from that country, they invest those dollars back into the U.S. (buying our Treasury debt, investing back into U.S. capital markets). If they don't want our dollars, there is no deal. So the attractiveness of the U.S. dollar is at the heart of the trade deficit issue - we provide dollar liquidity to the world, they fund our deficits, and we get the products we want from other countries. The symbiotic relationship between trade and currency is crucially important, and something we study, analyze, and apply diligently at The Bahnsen Group.
Politics & Money: Beltway Bulls and Bears
- I am not interested in forecasting who is going to be the Democratic nominee at this time, let alone who is going to win the Presidency. What we do know is that Sen. Elizabeth Warren is at least a serious contender for the nomination (by most indicators she is in second place in polling, and in the betting odds she has a significant first-place position). And then if she does win the nomination, most people on both sides of the aisle would agree that either side has a chance to win. So all that to say, there is something between a "not insignificant chance" and a "50/50" chance that Elizabeth Warren could be our next President. You can do with that what you wish (and you can guess how I feel about it). So when she says that "on her first day in office she will sign an executive order that ... banks fracking everywhere," what are we to make of it? Well, for one, a bank on private land fracking would require legislation, so good luck with that ... Natural gas production has seen its percentage from federal land go from 25% to 13% over the last decade. In the period of time that fracking has enjoyed its renaissance, U.S. CO2 emissions have seen the largest reductions in history. This issue, politically, even apart from the environmental and economic implications, strikes me as brutal in Pennsylvania, Ohio, and Colorado.
Chart of the Week
I have written a great deal over the years of my disagreement with the classifications of "growth" vs. "value." That said, within the bounds of how our industry classifies and measures these things, data exists that can help inform us within the right context. Note the following distinctions when people talk about the market being overvalued, and when they talk about the rotation between growth and value...
Quote of the Week
"Half the work that is done in this world is to make things appear what they are not.”
-- E.R. Beadle