The Bond Market, a number of market analysts and President Trump were all ahead of the Federal Reserve once again, in calling for possible rate cuts in 2019, even though there were no signs of recession yet. For several months last year there were calls that the Federal Reserve was tightening too quickly by raising rates and reducing their balance sheet at the same time (policy that had never been done before). The bond market signaled that the Fed was more than a little aggressive in tightening. Finally, we are at a point where the Federal Reserve seems to listening to the data better.
Why all the concern over the Fed? Because historically an "inverted yield curve" (where short-term rates are higher than long-term rates) has been an excellent (and reliable) indicator of a coming recession. Many have already been discussing the "inverted yield curve" and using it to sound the alarm for recession. We believe this is premature because an inversion between the 2-year and the 10-year treasury has been the better indicator of recession, and as of yet, the 2-year and the 10-year treasury are not inverted. However, with both the Fed Funds Rate and the 1-year treasury above the 2-year treasury rate, it's reasonable to ask if the 2-year might also push higher than the 10-year treasury rate (creating the inverted yield curve that has historically indicated recession). The market is responding well to the Fed's recent comments because they indicate the Fed listening better and is now willing to cut rates if conditions demonstrate they should. This reduces the risk of an "inverted yield curve," and hence a recession.
The equity markets’ multi-week losing streak ended on expectations that the Federal Reserve may cut interest rates perhaps as early as this month. Fed Chairman Powell stated that the central bank will “act as appropriate to sustain the expansion,” and other Fed officials indicated a willingness to reduce interest rates to sustain economic growth in response to the potential slowdown from the trade disputes. The DJIA led all indices with a 4.71% gain followed by the S&P 500® Index (4.41%), the Nasdaq (3.88%) and Russell 2000® Index (3.34%).
In May, employers added only 75,000 jobs; still, unemployment remained at 3.6% and new claims remained near recent lows. Investors welcomed the low new jobs number on the assumption that the report will provide support for the Fed to lower interest rates. Also, job gains in March and April were revised lower by 75,000 jobs; the three-month average of 151,000 is well below the 238,000 level at the start of the year. Severe rains and flooding may have contributed to the low numbers; for example, farmers are facing the worst crop planting conditions in over thirty years.
On Wednesday, the U.S. and Mexico began negotiations aimed at stemming migrants from entering the U.S. in order to avoid President Trump’s 5% tariff due to become effective on Monday. The tariffs would hurt both economies: the U.S. imports many products, notably auto industry-related products, while oil exports to Mexico may be subject to retaliatory tariffs. Some economists believe that a tariff increase beyond the initial 5% level could push Mexico into recession. Late Friday afternoon, President Trump accepted Mexico’s offer of tougher immigration enforcement as sufficient to dissuade him from levying a 5% charge on all Mexican imports.
President Trump indicated that he will wait until after this month’s G20 meeting to decide on extending tariffs on another $300 billion of Chinese imports. U.S. and Chinese officials are expected to meet during the G20 to discuss the terms on which to restart trade discussions. Many companies are quietly expediting plans to reduce exposure to tariffs by moving production out of China.
Companies are nearing the “quiet period” prior to reporting second quarter earnings. Global growth continues albeit at a slower pace; the World Bank recently revised 2019 estimates of global economic growth from 2.9% from 2.6%. The domestic equity markets remain volatile in response to progress, or lack thereof, in trade negotiations. Second quarter earnings should shed some light on the impact of trade concerns on individual companies. Headline news will likely sway market sentiment for the remainder of the month.
Source: Pacific Global Investment Management Company
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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