In The Books

In the books.  Stocks rose in the final session of the quarter as fund managers rebalanced their portfolios for an uncertain quarter ahead.  Consumers are confident about the future as many states are slowing or rolling back re-openings.

 

N O T E W O R T H Y

 

All about control.  Well, here we are in a new month, a new quarter, and a new half.  Looking back to the New Year… nah maybe not, let’s just say it was bit wild, but the markets could be in a far worse situation given the economic impact of the pandemic and subsequent lockdown.  Unemployment is still a big problem, and the US economy pulled back at a record pace. However, evidence suggests a sharp increase in economic activity in the third quarter, which will hopefully include improvements in the labor market.  On labor markets, economists are not so sure.  Though many expect unemployment to improve, history shows us that it doesn’t typically improve at the same pace as the economy.  Hopefully, history will not repeat itself.  Despite all of the market calamity in the first quarter, the markets reversed course in the second with some indexes reaching new all-time highs.  The Federal Government and the Federal Reserve had a big hand in that.  The former enacted the CARES act which pumped an unprecedented amount of fiscal stimulus into the economy, while the latter added an unheard-of level of monetary stimulus.  The Fed, once known for fine-tuning an obscure interest rate up and down to control the pace of the economy, has become a superstar.  They have become a lender to well… everyone.  They have supported the financial markets through direct and indirect purchases of all sorts of bonds from all sorts of sellers.  With interest rates, they have pegged the ones they control to nearly 0%, which, under normal circumstances, would do the trick on its own.  But these are far from normal circumstances.  So what will the Fed do in the second act now that it has essentially thrown the kitchen sink at the markets?  There are still many things that the Central Bank can do, but two tools keep coming up in virtual water cooler discussions amongst economists.  The first is negative interest rate policy (NIRP) which seems pretty unlikely for now as the Chairman and many voting members have made it infinitely clear.  The second is Yield Curve Control (YCC).  This afternoon, the Fed will release the minutes from its last FOMC meeting and many Fed-watchers are anticipating that YCC was discussed.  So what is YCC, actually?  Remember how I referred to that obscure interest rate above.  That is the Fed Funds Rate, which is the Fed’s primary policy tool.  It is the rate at which commercial banks borrow and lend funds overnight between themselves, usually to meet reserve requirements.  See what I mean by obscure?  I don’t know about you, but I can’t remember the last time I borrowed money overnight… well maybe to buy a slice of late-night pizza in college.  Most of us, companies included, borrow money for longer periods of time and the interest rates we pay are largely controlled by the markets.  Supply and demand.  Too much supply causes rates to go up as does low demand.  As I have noted many times recently, supply has reached a record pace as companies scramble to borrow money in order to fill gaps caused by the economic pause.  Demand is weak because yields are low and investors are expecting inflation to kick in after 2021, which would lower real yields.  This environment threatens to cause interest rates to go up, thus dampening the effects of monetary stimulus.  Remember, low rates accelerate growth while higher rates pump the brakes.  Right now the economy needs acceleration.  Enter the Fed and Quantitative Easing.  They simply purchase lots of bonds, increasing demand and keeping rates low.  If they want to lower 10-year yields, they simply buy a lot of bonds that mature in 10 years.  They have been doing just that.  Yield Curve Control is a variant of QE but with a more directed approach.  YCC involves the central bank setting yield targets for various tenors (that is time to maturity for a bond).  If yields creep beyond their target, the Fed speeds up purchases, and vice versa as they approach them.  A similar strategy was successfully deployed during WWII and many expect the Fed to use it once again in months ahead.  What the policy really achieves is lower long term interest rates… by policy and not market force.  That is good news for corporate borrowers and consumers as well (think mortgages and car loans).  For lenders and savers always on the hunt for higher yields, lower long term yields make it increasingly difficult to get lower risk returns on their investments.  The FOMC minutes will be released 2:00 PM EST.

 

THE MARKETS

 

Stocks traded up in the quarter’s final session on optimism that things will… eventually… get better.  The S&P500 rose by +1.54%, the Dow Jones Industrial Average climbed by +0.85%, the Russell 2000 Index traded up by +1.42%, and the Nasdaq Composite Index increased by +1.87%.  Bonds slipped and 10-year yields rose by +3 basis points to 0.65%.

 

NXT UP

 

– ADP Employment Change (June) is expected to show an increase of 2.9 million private sector jobs compared to last month’s decrease of -2.76 million.

– Markit Manufacturing PMI (June)  is expected to come in at 49.6 in line with prior estimates.

– ISM Manufacturing (June) may have risen to 49.8 from 43.1.

– FOMC meeting minutes (June 10) will be released at 2:00 PM EST.

– This morning, Macy’s and General Mills beat estimates and we will hear from Constellation Brands before the opening bell.

daily chartbook 2020-07-01