The infamous Fed June FOMC meeting came and went. It was an extremely precarious one for Fed Chair Powell, as he had to juggle between giving the market enough juice that the Fed could ease if need be but not spook them by not cutting just now. It was perhaps one of his best performances yet, as the statements were clear and concise -- spoken like a true economist.
The Fed concluded that the economy was growing moderately, although global growth and trade risks loomed, unemployment was at record lows and labour market strong. They said they would continue to monitor developments and will do what it takes to sustain expansion. They removed the word "patient" from their statement -- and by saying trade risks have added uncertainty, Fed Powell left his options open. If President Trump, by some divine intervention, decides to back down in his aggressive rhetoric against China, then the Fed would have dodged a bullet and the market will heal itself, so to speak.
Leading up to this meeting, it was quite astonishing that most of the market participants expected 3 rate cuts for this year alone, with a 100% probability of a 25-bps cut in July. That seemed rather premature, especially as the market is at all-time highs, which was even mentioned by Powell.
It is virtually impossible, close to suicide, if the Fed embarked on cutting rates yesterday when the fate of the markets and the economic cycle rested solely upon the voluntary spasms of President Trump and his mood swings. It is best to see the damage and then act accordingly, and not to inflate the bubble further. Rather than Powell, it is Trump who should be demoted or at least such extreme powers to influence markets taken away.
Eight members agreed to a rate cut by end this year, with the Fed dot plot curve implying just one rate cut for 2019. All in all, the statement was a tad bit hawkish, as they did not cave into the bond market woes with the 10-year Treasury yield now trading below 2% for first time since November 2017. But the dollar fell and bonds rallied further, taking equities higher, too.
The bond market has given up all the yield gains since 2016, yet the equity market is still at close to highs -- quite remarkable. One asset class implies doom and a system that is clearly broken (rightly so) and the other asset class thinks the cycle can never end, as the Fed will keep printing money and churning Quantitative Easing until kingdom come. Rather than get into the academic debate of the serious warped implications of this scenario, no wonder investors are rushing to cryptocurrencies, as one asks the question "Is any Fiat currency safe with central banks on a path to keep devaluing them continuously?"
So why then did the market rally when the press release was a bit hawkish? Short and simple answer, liquidity and quadruple witching this Friday.
June is typically a very important month for index and stock options expiration as it tends to fall on the third Friday of the month, and is a quarterly expiry where a lot of funds have very big positions in their futures. There are a lot of puts and calls expiring at key strikes of 2900, 2950 and 3000. What this means is that market makers have to hedge their exposure tick by tick, as close to Friday, they have no clue if they are long or short as that can change in a matter of 50 points. The market tries to remain pinned close to expiry, with the real move able to be seen after.
If one were to look at the moves across asset classes in the past week, there is no real logic whatsoever. The bond market is at new highs, with yields collapsing across the board, screaming for rates to be lower as we seem to be in a real breach of a recession.
Gold is trading close to $1380/ounce (+8% in June alone), and copper is still below $6000/tonne, which tends to be a true reflection of global economic growth and heart beat for the Chinese economy -- hence the nickname Dr. Copper. Even oil is trading close to $60/bbl Brent as demand slowdown has offset most of the OPEC cuts set in place since last December. The equity market (S&P 500) is the only market that is up back at highs -- + 6% in June -- with technology stocks up 13% in the last week. Something does not add up.
Trump cannot back off his trade war now by giving in, as he will most likely lose reputation and be labelled a weak candidate. China is more than happy to have a protracted trade war rather than give into his bullying ways. China is no Mexico.
The market is cheering for rates to be cut, but forgets they are being cut on the back of global growth collapsing, which is negative for risk assets, not positive. It is important to see the bigger picture than be fooled by the immediate knee-jerk reaction as there is a lot of liquidity behind these day trading strategies that exaggerate the moves on the way up and down. The "real fundamental" move does prevail, one just needs to be liquid enough to be around to capture it.
It's simple, either the bond markets needs to fall to project fewer rate cuts for 2019 or the equity markets need to fall to imply that same level of weakness. The market cannot have its cake and eat it too.