Shopping, not stopping. Stocks rose yesterday as retail showed resolve in earnings. Consumers continue to shop, keeping the retail sector and the economy moving forward.
MY TWO CENTS
- Split decision. Investors were left somewhat stunned, if not disappointed when Fed Chairman Jerome Powell said that last month’s rate cut was a mid-cycle adjustment and not the beginning of an easing campaign. The statement itself was enough to put the summer rally in equities to sleep, giving central-bank-stimulus addicted bulls a dose of reality. As always, the sting of those words wore off with time and many started to believe that the Chairman just made a poor choice of words. Yesterday’s release of the minutes from that very Fed meeting put a fine point on the facts behind the rate cut. Those words were, in fact, very carefully selected and agreed upon by the Fed. The minutes showed that at least two Fed governors wanted a 50 basis point cut while others argued against any rate cuts. Still, the majority of the committee agreed that the move was a temporary policy adjustment. The minutes further noted that the Fed felt that some of the headwinds from trade disruptions eased a bit prior to the meeting. Though the tone of the meeting was still dovish, there was no mention of the path for future rate cuts. Instead, the body took the safe path agreeing to be flexible data dependent. It is important to recognize that a lot has occurred since those minutes were recorded in July. The EU has had a run of weak economic numbers, new tariffs have been proposed, Brexit looms ever closer, and another portion of the yield curve inverted. While the equity markets yawned their way past the minutes, bond markets responded to the lack of clarity, pushing 2-year treasury yields up. Remember that short maturities are highly tied to monetary policy, so when the Fed is in easing mode, maturities of 2 years and under typically go down. Yesterday, 2-year yields jumped by +6 basis points to 1.57% causing the 2-year/10-year yield curve to flatten out by -3 basis points to +0.9 basis points. Fed funds futures predict a 98% chance of a 25 basis point rate cut in July with a 0% chance of a 50 basis point cut. Just a week ago, futures pointed to a 31.5% chance of a 50 basis point cut. All eyes will be on Chairman Powell tomorrow morning when he gives his speech in Jackson Hole.
- Negative yield contagion. I have been writing quite a bit about low and negative yielding bonds and yesterday morning I reported to you that Germany offered their first ever 0% 30-year bond which was, not shockingly, also their weakest demanded auction ever. So where do you put your safe money if solid industrial giant Germany offers no return on their long maturity bonds? Retail investors typically respond to low or no yield by going into riskier assets like stocks, but institutions that rely heavily on bond markets are required to stick to fixed income instruments. For them, the only answer is to find alternative sovereign debt that offers more yield. That means demand for non-German, high quality, sovereign debt goes up. In Europe, the only countries which offer longer yields above 1% are Italy, Greece, Portugal, and the Czech Republic, all of which are considered lower quality because of weak economies. That leaves the US long bond as a strong contender. Increased demand drives prices up and yields down. Long maturity treasury yields fell yesterday morning in response to the German auction but ultimately reversed after the Fed minutes, but we can expect continued pressure on longer US treasury yields going forward.
Stocks traded up yesterday after strong pre-bell earnings from Lowe’s and Target gave investors hope that the consumer is still carrying the economy. Later in the session President Trump backed off from his one day earlier hint of tax cuts, stating that the economy was in good shape, although the market did not respond. The market also shrugged off the Fed minutes which did not hint at further rate cuts. The S&P500 traded up by +0.82%, the Dow Jones Industrial Average climbed by +0.93%, the Russell 2000 advanced by +0.79%, and the NASDAQ Composite Index rose by +0.90%. Bonds fell and 10-year treasury yields increased by +3 basis points to 1.58%.
– Preliminary IHS Markit Manufacturing PMI is expected to have increased to 50.5 from 50.4. Services PMI is expected to be 52.8 down from 53.0.
– The Conference Board will release its Leading Index, which is expected to have grown by +0.3% after last month’s -0.3% drop.
– This morning Hormel and BJ’s Wholesale Club beat estimates and we will hear from Dick’s Sporting Goods and Gap before the bell. After the close earnings will include Ross Stores, Salesforce, VMware, and HP.
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