If you follow my work, I have outlined at the beginning of the year how Western central banks would start turning Dovish in Spring, with rate cuts occurring very soon afterwards. I maintained rates would be cut before Fall.
Mario Draghi commented about the ECB further cutting rates deeper into the negative and more easy money…a day before the Federal Reserve Interest Rate decision. The Fed essentially accomplished its goals via the ECB: Stocks getting a pop on reassurance of rate cuts and cheap money, as well as bond yields going lower.
Today, Jerome Powell spoke and dropped the word “patience” from his rhetoric. The Fed is expecting to cut rates once this year. As I have said, the Fed would lay the foundations for this meeting, and then they will cut next month in July.
I believe this cut will be a 50 basis point cut. Why? Look at the yield curve and also look at the Fed Funds rate. Forget about the stock market. Look at the bond market if you want to know where we are going. In this era of ‘fake news’, the debt market charts are a source of real news.
What makes things ever worse is that we are heading towards a recession when central banks really have no ammo or tools in their toolbox. In this period of rate normalization, the Fed only made it up to 2.50%. When the last recession happened, the Fed and other central banks cut rates by at least 400 basis points or 4%. They cannot do that now. They will have to go to 0, and then from there who knows. I don’t even want to speak about the bond markets when rates are being brought lower…there will be no reason to hold negative yielding government debt.
So besides the deteriorating economic data, what is another signal that a recession is coming? The yield curve and how people would rather hold money in the short term rather than the long term because the future is uncertain.
At the top of this post, I have a monthly chart showing the 10 year yield paired with the 3 month yield. The red line is zero. When we are above the red line, the 30 year yield is higher than the 3 month…which is how things should be. When you invest for the longer term, you expect to get a higher yield.
When we are below the zero line, the 3 month is yielding more than the 30 year. An inverted yield curve. If you look at the the yield curve, the 3 month is dominating everything except the 30 year.
The yield curve has predicted 7 out of 9 recessions. It is a pretty good indicator as it tells us that people are looking for shorter term gains and return rather than the long term. They are nervous and uncertain about the long term.
You can see with the chart I posted, that when we dipped below, they occurred during periods of a market crash. We had the dot com bubble in 2000, and of course the great financial crisis of 2008.
As you can see, we have dipped below, or inverted recently. Since May to be exact.
Expect the Federal Reserve to cut rates MORE than once this year in order to drop the yield on the short end of the curve to attempt to normalize the yield curve.
The bond market is telling us that rate cuts are coming. I repeat again as I have many times on this blog: follow the bond markets!
The problems of 2008 were not solved. We papered over them with more debt. This next crisis will be much worse.