Bonds: Total Market
(Washington)
The Fed is facing a herculean task, argues the Wall Street Journal. That task is to keep inflation at its target, while also steering a moderation in growth. In other words, how does the Fed keep inflation in check without causing a recession? One way to consider this challenge is to think about how the Fed may approach it: “focus more on the domestic economy and keep nudging interest rates higher to combat inflationary concerns, or pay greater attention to stresses abroad and in the markets, and hold rates steady or even nudge them lower”, says the WSJ.
FINSUM: We think this is not as hard as rumored. Our view is that the Fed should freeze rate hikes and broadcast that a long-term freeze is the plan. That should put the economy (and markets) on solid footing, and keep things from getting too out of hand.
(Washington)
If that headline sounds like relief to your ears, read further. While there are no clear signs out of the Fed yet (other than increasingly dovish talk), new data is showing that the Fed may cut rates in 2019. The forward spread shows that traders are anticipating a rate cut at the beginning of the year. Two-year Treasuries have seen their yields slip below one-years’. This is the first time this has happened since 2008. According to a market strategist at Pimco, “This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate”.
FINSUM: We don’t think the Fed will cut in the first quarter unless something more drastic happens, but we are quite sure they won’t hike.
(New York)
The market has been very worried about a potential bond market meltdown. Both investment grade and high yield debt have seen major losses lately as fears have mounted about high corporate debt heading into a possible recession and downturn in earnings. One of the big worries is that there will be a surge in BBB (the lowest rung of investment grade) debt that falls into junk status. However, Bank of America is more sanguine, arguing that growth is solid and companies have actually been issuing much less debt, and will continue to do so. Their view is that companies are in a much sounder financial position than before the last crisis.
FINSUM: The debt gorge that happened over the last several years is inevitably going to have consequences, and we think BAML is way too relaxed about the risks.
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(New York)
Where to put one’s money in 2019? That is the difficult question every investor must face at the moment. For a long time “TINA”, or “there is no alternative”, was the mantra which kept guiding capital into stocks alongside miniscule yields. Now with rates and yields rising and stocks having seen big losses, where should investors turn? The reality is that bonds seem likely to outperform stocks next year, at least according to JP Morgan. The bank thinks EM debt is likely to have a good year as once the Fed stops tightening the Dollar will likely weaken, giving a boost to EM assets.
FINSUM: In our view, a lot of damage has already been done to stocks and there are now some very interesting buys. Furthermore, short-term debt has seen yields rise high enough that you can get decent returns without a lot of interest rate risk.
(New York)
Pay attention, the yield curve just inverted. And we are not talking about some esoteric swap rate most have never heard of. Yesterday the spread between two-and five-year Treasuries fell below zero, the first major inversion of this bull market. The 2- and 10-year spread is the most typical benchmark for gauging an inversion, but the 2- and 5-year is significant. Yield curve inversions are one of the most accurate predictors of recession, with one preceding the previous several recessions.
FINSUM: One very important thing to remember is that it often takes many months (or years) for a recession to begin once a yield curve starts, so there is still plenty of room for the economy (and markets) to run.
(New York)
This is a day where investors need to take a deep breath. Markets are plunging, the yield curve just inverted, and there are major fears about the durability of the US-China “truce”. One thing to take heart in is that even though they are good predictors, a yield curve inversion doesn’t mean everything. It is important to note that it is the two and five-year Treasuries that have inverted, not the two and ten, which could mean this is just a temporary kink. For instance, in 1998, this pair turned negative without the rest of the curve following suit.
FINSUM: On top of the last point there, remember that inversions don’t cause recessions, they are just the market predicting slower long-term growth. That said, they seem to create self-fulfilling prophecies.