Today is the heavily marketed Fed meeting where the markets are looking to get some insights into the easing (almost no one expects a hike) timetable for 2019. This is coming off the back of the news from the ECB, where Draghi is proving not to be a lame duck and has started to talk up easing policy should the markets continues in the current trend.
With all of this easing talk (and some positive tweets about the trade negotiations) we are seeing US markets nearing their all time highs which is great news for investors but raises some questions about the near future. Should more money be allocated to US stocks in the coming months? Should money be taken off the table? The answer to these are all based on the underlying reality vs the projections of the markets. A Fed cut is a good thing under the assumptions it is in anticipation of a slowdown in the second half of the Year. With the Fed getting ahead of any negative data in the US, the markets will be able to avoid the sell-off that would accompany an adjustment in growth expectations. If the cuts come as a reaction of negative data in the markets we will see the markets adjust to the news until they can determine that the easing policies of the Fed have been effective. Some argue that it would be harder to turn sentiment with only 250 basis points to cut so getting ahead of the data is key.
Insights into this will come from the Fed "dot plot" where the members of the FOMC all predict where interest rates will be at certain times in the future. For the early scenario to be in play we should see significant moves downward in these dots as the voting members change their expectations. A lower expectation of the longer term interest rates will point towards the committee feeling they will be unable to avoid the slowdown with early cuts and there will be a longer trend in "lower for longer" along side other major economies.
You can't look at the UK market or the currency without taking into account the current state of Brexit. The postponement of the deal to October and subsequent election caused the Pound to drop. The stock markets have been taking this news fairly well staying in line with other major indices. The question now comes down to the data. Will there have to be a pronounced decline in UK data to prompt the British government to take early action against the threat of a no deal Brexit? News today shows that steps are trying to be made to prohibit that from happening, but without a sense of urgency it will be important to see how the vote goes.
Like many investors are probably thinking, I like the UK as an investment opportunity but am holding off in light of the political threat to the markets. This paralysis is going to seep into the economy as uncertainty continues. For this week I am going to keep an eye on the BOE governor to see what he thinks monetary policy will have to do in this interim period, and after.
Markets are again in the red this AM about the Yield curve going deeper into inversion. With the 10 year at a yield of 2.1% and the 3 month at 2.34%, it pays to keep your money in cash short term while avoiding locking in anything further out on the curve. This has been a sign of a recession in the past and has the markets starting to sell off as a result. Long term what does this mean?
If a recession is on the horizon it is almost guaranteed that the expected that the Fed will react. A curve that is this inverted is a telling sign that many investors are expecting the shorter end of the curve to come back in line with the expectations priced into the longer end of the curve. If these cuts do occur, and remain lower for longer, like we have seen in the past, there is a good chance of getting a rise in assets providing the yield that many investors require.
Banks will be one of the beneficiaries of lower rates. A steepening yield curve is where traditional banks earn their profits. While the curve is flat or negative they have to borrow at a higher rate then they are lending. This will slow their ability and desire to lend money, slowing the economy, and causing the Fed to look at lowering rates. ETFs like the KBW Regional Banking are becoming cheaper in the sell-off and starting to get a yield that is nearing the 3 month. As the market continues to price in the trade wars and recessionary fears, financial ETFs might be worth looking at. If the Fed goes on a program of interest rate cuts, the profitability metrics of these companies will increase, and the yield they provide will look more attractive.