So, the MSCI World Index just recorded the best June performance ever! Pushing global stocks to record highs and a return of 15.5% for the year so far. Doing this run all in front of an expected recession. Go figure. The turn around? You can thank the Fed’s back flip, succumbing to pressure from both the White House and the market forces. From the hike in December last year the market had priced in expectations of no change, until April which it began to price in hikes. This month the Fed capitulated and agreed. Whilst the Dot Plot shows no change, the rhetoric is very dovish. The market no has implied expectation of 90 basis point cut this year. It is priced 100% chance of at least 25 basis cut on July 31st.
On the other side of the coin though is the looming recession as depicted by the yield curve inversion, along with the US/Sino trade spat. That spat is still weighing on the markets as the recent G20 meeting in Osaka resolved nothing. The US Treasury market has only one bond above the current Fed Fund rate (2.5%), that is the 30 year bond with a yield of 2.53%. So, the curve goes from 2.09% at the 3 month mark, to 1.75% on the 2 year bond to 2.09% on the 10 year then 2.53 on the 30 year. Every time the yield curve inverts it signals a recession within 2 years. That recession hits as the yield curve flattens and reverts to positive. If the Fed does cut by 0.5% on July 31st that will flatten the yield curve almost immediately, by pushing the short end below 2% to where the middle of the curve is currently sitting.
So, whilst stock traders are loving the cheap money and want more of it from the Fed cut, I think they need to beware that a cut is actually Damocles Sword for them. It seems to me that traders have a short memory.
The US Dollar is not following its historical fundamental path and just last week broke the uptrend it has been in since April 2018. There is however a very strong support level at 95 it may hold onto. With the Greenback weakness, Gold and Bitcoin have had stellar runs this month. Not normal for them to do so this time of year, and with stocks higher one cannot contribute it to Risk Off (safe haven) flows either. The attraction for an asset that has zero yield such as gold and bitcoin is being attributed to: “It’s better to own zero yield than negative yield”, pointing the finger at the drastic plunge in global bond yields.
Elsewhere in currencies we have the Aussie swinging away to the tune of Trump’s Twitter account, the ebb and flow of trade relations. The Kiwi and Loonie are also pretty much the same, being in the same “commodity” boat and over exposed to China. Pound continues to flounder on Brexit and politics with economic data mute. Euro is also a hard one to be a long-term buyer of, with the ECB recently indicating the willingness to cut again. Whilst the Yen shorts got caned for being so presumptuous, although as stocks continue to rally, they will come back in favour.
Looking ahead, we expect all central banks to keep rates steady whilst maintaining a neutral to dovish stance. Apart from the US Fed, we do expect them to cut on the last day of the month, it is simply a matter of by how much.