The much-anticipated Fed July FOMC meeting on 31st July is drawing closer. Fed speakers are using this opportune time to posit their views. Perhaps some would be better suited to remain in academia than to have any influence over financial markets. Yesterday NY Fed President John Williams said in a speech that "it's better to take preventative measures than to wait for disaster to unfold", implying the Fed should cut rates aggressively ahead of any slowdown. Sure thing, if that were the case then the Fed would have cut 25 bps every month in 2018 alone, and we would be in a world spiraling with inflation and lagging growth - a captain clearly losing control at the helm of a boat. The probability of a 50-bps rate cut for July shot up to 60%. The dollar fell along with Treasuries, taking gold and equities higher. Overnight, the Fed was trying to back track Williams comments by suggesting it was an "academic speech of 20 years of research" and not about policy per se.
In a market hanging by a thread, such comments should be reprimanded as just one word out of sync is enough to get futures traders all over the tape to close their positions, violently changing the momentum. Backtracking is not helpful when charts are broken. A good example is copper three month LME futures that broke upwards towards $6150/tonne ~ +3% on the day. Looking at speculative positioning in LME/Comex futures, traders have been short copper for good reason. The trade war is at an impasse with no signs of a deal imminent given the arms sales to Taiwan, plus dismissed requests for U.S. to remove tariffs and the ban on Huawei. It seems this could go on for longer. Does the market care? Of course not, all is well as the Fed and their ever-printing machine lives.
Now let's take a look at the flip side of this argument. The market is close to expecting a 50-bps cut when the Fed meets. Given Powell's patient and data-dependent approach, he might resolve to a 25-bps cut with talk of "data needs to be monitored". Given the extent of Fed dovishness that is priced in, this would certainly not make the traders happy. It seems the market is too bullish on 50 bps cut. This year 2019 Powell had done a pretty good job just with his words at market extremes to contain the damage. After all, if a real recession does start (if we are not in one already), then the Fed has only about 225 bps of room to maneuver vs. 500+ bps back in 2007/2008. The Fed knows it will be checkmated if it starts too soon and too aggressively, especially if the S&P 500 is at all-time highs. How much would it need to cut if the S&P 500 fell 10%? A 100 bps? Ouch.
The other academic question one should be asking is does the Fed really need to cut right now in the cycle? Since their last communique the first week of July, U.S. economic data has actually reported better than expected numbers. Just yesterday the July Philly Fed Manufacturing Index printed at 21.8 with improvements in new orders and outlook. It seems that proceeding with a 25bps rate cut to undo their December increase seems most likely, but that is it until the data gets significantly worse or market drops.
Everyone is fixated on the Dow Jones Industrial Average and S&P 500 making new highs, but when one looks at more "real" indices like the Russell small-caps and Transports, the trend is strikingly dissimilar. This divergence is not a sign of a healthy market at all. China's GDP miraculously showed a smooth 6.2% GDP number, but when we look at measures like furniture sales or property prices, the trend is quite worrying. We know China fudges their official data, so trend is more important than the actual number. The only reason anyone is long here today is because they think Fed will stimulate their way out of a recession. But there needs to be one to start off with.
Copper equities had started moving higher breaking away from the Copper price of the last few weeks on hopes of a rate cut and trough in economic data. The copper price played catch up today as traders got caught short. It is now more in line with its equity brethren. The dollar is at risk of rallying following a not too dovish Fed, which risks commodities like copper selling off after a false break. The U.S bond market needs to be monitored as rallying yields will accelerate this selloff even further as entire world is relying on dollar yields staying low.
It is easy to get washed away when overnight headlines move prices so far against us, but one needs to take a look at the risk reward and genuinely and ask themselves, "Is it worth it right here?"