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Friday, 5th July 2019 09:07 - by Shant
Wednesday marked some notable price action in financial markets, headlined by the new record highs seen in the S&P 500 which is now looking to tip the 3000 mark - as futures markets are suggesting. Alongside this, US Treasury yields continue to fall, with the curve out to the 30yr now trading below Fed funds. This will no doubt been seen as forceful pressure on the FOMC to cut rates at the end of this month, with the data so far suggesting 25bps will suffice. Sentiment on this may be swayed by the employment report from the BLS Friday, as markets are currently hoping that the disappointing gain of 75,000 jobs (against expectations) will correct in June. Irrespective of the number, the bond markets have boxed Fed chair Powell into a corner and we now have the prospect of rate cuts alongside stock markets trading to record highs.
However, the Fed - and certainly the White House - will argue that monetary policy elsewhere is distorting financial conditions back home looking past nominal rates. As we saw ahead of the last FOMC, the ECB president Mario Draghi - who looks set to be replaced by IMF head Christine Lagarde - chose a well-timed opportunity to communicate some verbal policy softening of his own. Policymakers in Europe are now talking up fresh usage of the monetary toolkit, which suggests another round of QE is just around the corner. As it stands, the markets are also pricing in another 10-20bp of cuts in the deposit rate, and investors are piling into European bonds amid the prospect of further debt tranches falling into negative yield territory.
Both in Europe and in the US, the common narrative is sluggish inflation - a measure which continues to bedazzle respective central bankers and which has shackled the BoJ to the perpetual asset purchasing program, showing little sign of tapering, let alone a potential end in sight. However, Japan's inflation rate is stuttering below the 1% mark and in Europe, the core CPI rate is pivoting either side of this level also. In the US, core PCE - which is the Fed's preferred measure of inflation - is near 1.6%. Despite this, and having built up a rate buffer, dovish members of the FOMC are calling for softer rates, and to some degree - as I have mentioned - long end rates are perhaps forcing the central bank's hand.
In pre-emptive mood, risk appetite is taking positive expectations (of renewed easing) to new levels. Case in point is the rally in the Dax. Heavily weighted with export-reliant stocks, the index has responded with near perfect correlation as the German 10yr yields dip below -40bps - below the ECB's deposit rate. Investors are also buying into Italian bonds, with the FTSE MIB racing back up to the highs seen in April this year. Gains here have been bolstered by the news that Italy will not be facing a penalty after the coalition government promised to trim its budget over the next two years. Quite how penalising Italy would alleviate any of the pressure can be deemed logical, but the easing of political tensions has nevertheless patched up some of the damaged investor sentiment - albeit the promise of further broad-based QE is largely behind it.
So looking across the board, global stocks are pushing higher still, led by Wall Street as US markets continue to outperform. Bonds are also rallying as the promise of further easing prompts the market to hoover up yield wherever it can find it. The benchmark 10yr Note is now below 2.0% and some outlandish calls are now coming through that this could be heading much lower still! At the same time, Gold is also in the ascendency, and as I suggested earlier in the year, the asymmetric risk profile a few months back favoured a positive outlook either way. And so it comes to pass - the Goldilocks scenario is all but complete. For Donald Trump, however, this would be finished off by some convenient Dollar softening - something which looks more likely to gain traction once the Fed pulls the trigger on rate cuts - unless the president starts to verbally crank up the pressure on the usual suspects. Gold is playing well into my macro expectations, but it looks as though it may be time to start investing in long volatility structures also.
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.