Don’t Look Down!

Don’t look down!  The rally in stocks took a breather yesterday as investors assessed how fast and just how far we have come. New global virus cases hit a new high yesterday while more and more shelter orders are lifted in the US.

 

N O T E W O R T H Y

 

What about interest rates?  The FOMC started its 2-day policy meeting yesterday and will wrap up this afternoon with an announcement and a press conference.  Nothing new there, it is what the Fed does, amongst a few other things.  What is new about the meeting is this never-seen-before economic situation. Let’s not dwell on the blows to the economy, companies, and workers… we have done enough of that in recent months.  Those aside, the Fed has been the shining light for the banks, many companies, everyday folks, and the financial markets.  When most people think of Fed policy, the first thing that comes to mind is interest rate policy in which the Fed lowers rates to give gas to a slowing economy and raises them to pump the brakes on an overheating economy.  The global financial crisis that coincided with the last recession (we can call it that now that we are officially in one…see yesterday’s note) made it no ordinary recession, earning it the “Great Recession” moniker.  It was so bad that the Fed had to bring out never-used-before tools like Quantitative Easing (QE) which involved the central bank’s purchasing bonds in the open market (mostly from banks) in order to pump liquidity into the system.  This most recent economic downturn caused the Fed to re-write the playbook completely.  First, they lowered rates to near-zero, which is pretty much as low as you can go (more on that in a minute).  Second, the Fed began to purchase all sorts of securities in all sorts of forms from all sorts of institutions, stopping just short of buying equities.  Third, they became lenders to non-bank entities such as municipalities and corporations.  The magnitude of the purchases has swollen the Fed’s balance sheet to never-seen-before levels.  Yes, there can be some negative implications of that, but for now the result of the purchases has been, unarguably, the shoring up of the banking system which is crucial to maintain corporate health and ensuring the mostly flawless operation of the complex financial system.  The end result was a rally in the stock markets which was largely driven by the Fed.  Now back to interest rates.  There has been much discussion around negative interest rates as of late.  I have written a great deal about ZIRP (zero interest rate policy) and NIRP (negative interest rate policy) in the past, mostly related to Japan and EU in which rates are negative.  In the beginning of May Fed Funds 2021 futures went over 100 for the first time indicating that traders were betting that Fed Funds would go negative.  They retreated back below the 100 mark just last week but there is still lots of “verbal” speculation around negative rates.  The Fed has made it quite clear that they do not consider negative interest rates to be beneficial, a pronouncement echoed by many economists and analysts.  The President is apparently a fan of negative interest rates, often jawbone tweeting at the Fed.  What happens if rates do go negative? In theory negative interest rates mean that a lender will actually pay the borrower instead of the reverse, which is typical.  So negative rates are bad for entities who make money on interest from lending… entities like: banks. Don’t cry for them though, they still get lots of closing fees, even when lending to big companies. How about the rest of us?  We lend money too, usually through purchasing bonds or placing our cash in money market funds. Negative rates means no return on our cash which will lead to massive withdrawals of liquidity from financial institutions.  That will certainly not help the banking system.  It may help stocks, especially those that pay dividends, strengthening the TINA (there is no alternative) case.  Ultimately, negative rates would be messy, if not confusing, and the jury is still out on whether they are actually stimulative to the economy.  Just look at the economic performance of Japan prior to the pandemic.  The Fed Chairman will certainly be pressed on negative rates today in his Q&A session.  We will also get a glimpse of interest rate projections from Fed Governors in their dot plots.  Those are largely expected to remain low but not negative.  Markets will be watching carefully starting at 2:00 PM EST today.

 

Look to the future.  It is clear that markets have factored in the recovered economy, choosing to overlook the still-ugly situation today.  I won’t lament on that any further because, as we say on Wall Street, the market is always right.  It is true though that markets do factor in the future. Financially speaking, stock prices are more heavily affected by future earnings and growth opportunities than current.  OK, so if stock markets are looking forward and we are all past the pandemic, maybe it is time to start thinking about other future factors that could impact corporate performance.  The Presidential Elections are around 5 months from now and Americans will pick a President who will impact policy through 2025.  Those policies will certainly impact stock performance beyond recovery.  It hasn’t happened yet, but it will soon, making the market narrative that much more interesting.

 

THE MARKETS

 

Stocks sold off yesterday, taking a break from its rapid ascent.  Tech stocks bucked the trend helping the Nasdaq Composite Index close in the green after climbing by +0.29% and briefly trading over 10,000 intraday.  The S&P500 sold off by -0.78%, the Dow Jones Industrial Average dropped by -1.09%, and the Russell 2000 gave up -1.94%. Bonds traded up and 10-year treasury yields fell by -5 basis points to 0.82%.  Crude Oil added +1.96% but a late-in-the day report that inventories are growing sent futures down over night.  Today’s EIA report will be closely followed to confirm the build in inventory, that comes at 10:30 AM EST.

 

NXT UP

 

– Consumer Price Index Excluding Food and Energy (May) is expected to be flat month over month compared with the -0.8% drop in April.  That would bring the year over year CPI Ex Food and Energy to 1.3% compared to last month’s read of 1.4%.

– The FOMC will announce its decision this afternoon at 2:00 PM EST.  Rates are expected to remain constant and the Fed is expected to continue its dovish stance, despite last Friday’s surprise growth in Non-Farm payrolls.  The press conference and Q&A will be closely watched.

 

daily chartbook 2020-06-10