Fed Minions Focus S&P 500 Investors on 2020-Q1

New York Fed president John Williams gave a prepared speech on Thursday, 18 July 2019. In the speech, he argued the Fed should do two things with its monetary policy learned from model simulations when it takes action to head off an economic downturn when interest rates are already low or are near what he calls the Zero Lower Bound (ZLB):

The first: don’t keep your powder dry—that is, move more quickly to add monetary stimulus than you otherwise might. When the ZLB is nowhere in view, one can afford to move slowly and take a “wait and see” approach to gain additional clarity about potentially adverse economic developments. But not when interest rates are in the vicinity of the ZLB. In that case, you want to do the opposite, and vaccinate against further ills. When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.

This brings me to my second conclusion, which is to keep interest rates lower for longer. The expectation of lower interest rates in the future lowers yields on bonds and thereby fosters more favorable financial conditions overall. This will allow the stimulus to pick up steam, support economic growth over the medium term, and allow inflation to rise.

Investors interpreted those statements as calling for a more aggressive series of rate cuts than the expectations Fed officials have set forward to date, which for a moment, caused bond yields to fall, the value of the dollar to drop, and stock prices to sharply rise, at least until the New York Fed was forced to step in to “clarify” Williams’ comments.

For the S&P 500 (Index: SPX), Williams’ speech had the effect of focusing investors on 2020-Q1 more closely, with the probability of a fourth rate hike spiking over 50% on 18 July 2019. A day later, those odds dropped back below 50%, as indicated by the CME Group’s FedWatch Tool:

That stock market investors have more closely tightened their focus on 2020-Q1 can be seen in our alternative futures ‘spaghetti forecast’ chart, which projects the potential future levels of the S&P 500 based on dividend futures-based model.

Even though investors maintained their forward-looking focus on 2020-Q1 and the expectations associated with that future point of time in setting current day stock prices, we believe the market is currently at a heightened risk of having investors shift their focus to other points of time in the future, where shifts toward any other quarter before 2020-Q3 would be accompanied by a significant decline in stock prices, with a shift toward 2020-Q2 being the largest and most negative. Such a shift would be driven by investors’ response to the random onset of new information, which provides the random element in the market’s quantum random walk.

Speaking of the onset of new information, here are the headlines that influenced investors during the third week of July 2019:

Monday, 15 July 2019

• Oil prices down on dwindling storm impact, Chinese economic data
• Bigger trouble, bigger stimulus developing in China:

• China second-quarter GDP growth slows to 27-year low as trade war bites, more stimulus seen
• China central bank injects 200 billion yuan in one-year MLF rollover, rate unchanged

Previous stimulus getting traction in China:

• China June aluminum output climbs to daily record – Reuters calculations
• China churns out record daily steel output in June – Reuters calculation
• China June industrial output up 6.3% year-on-year, beats forecasts, retail sales up 9.8%
• China June coal output hits record high as miners ramp up ahead of summer

S&P ends near flat as Citigroup results sink banks; Nasdaq hits new high

Tuesday, 16 July 2019

• Oil falls as Iran tensions seen easing
• Bigger stimulus developing in China:

• China’s premier says will make good use of ‘counter-cyclical’ measures
• China’s first half fixed-asset investment projects rise 81% year-on-year to 472 billion yuan
• China boosts local government bond issuance to $104 billion in June to spur economy

Fed minions set stage for rate cut:

• Powell says many at Fed seeing stronger case for U.S. rate cut
• Fed’s Kaplan: bond market signal may warrant ‘limited’ rate cut
• Fed’s Kaplan says sees an argument for a tactical rate cut
• St. Louis Fed wanted cut to discount rate in June: minutes
• Fed’s Daly says she is not leaning one way or the other on rate decision

Trump says U.S., China still have a long way to go on trade deal

Wall Street slips as bank earnings, Trump trade comments weigh

Wednesday, 17 July 2019

• Oil prices fall more than 1% after U.S. fuel inventories build

• U.S. crude oil stockpiles drop amid Barry, fuel posts large builds – EIA

U.S. housing market stuck in a rut even as mortgage rates fall

Fed’s George hints she could be open to lower interest rates

Wall St. falls as CSX results signal damage from trade tensions

• Trade, earnings worry drag on stocks; U.S. Treasury yields fall
• Starting with Netflix, FANG reports to test Wall St rally’s mettle – Note: Netflix’ bad news came after the market closed on 17 July 2019….

Thursday, 18 July 2019

• Oil falls about 2.5% as U.S. Gulf production returns
• Bigger trouble developing in China all over:

• China’s debt tops 300% of GDP, now 15% of global total: IIF
• Sliding Japan exports, manufacturing gloom heighten economic risks
• Poland’s central bank governor downplays surprising fall in output
• UK may be entering full-blown recession: budget watchdog

Bigger stimulus developing in China all over:

• ECB to cut rates in September, QE 2.0 still on the cards: Reuters poll
• Indonesia central bank cuts rates for first time in nearly two years to fire up growth
• South Korea central bank surprises with rate cut, likely to loosen again

Fed minions stoke rate cut expectations, then try to walk them back:

• Federal Reserve officials lay out case for aggressive rate cuts
• Wall Street rises as Fed’s Williams cements rate-cut expectations
• New York Fed takes unusual step of clarifying president’s speech – referring to New York Fed president John Williams’ speech

• Time for the Fed to join the computer age – commentary from Scott Sumner, on how to fix “the clown show experienced yesterday at the New York Fed” where confusion reigned among the Fed’s minions.

Stocks gain on Fed rate cut optimism; oil drops

Friday, 19 July 2019

• Oil climbs as Middle East tensions offset demand worries
• Fed minions continue sending mixed messages:

• A rally and a redirect: why the markets are so focused on the Fed
• U.S. rate cut will ‘ratify’ what people already expect: Fed’s Bullard
• Fed’s Rosengren U.S. economy ‘reasonable,’ no need to cut rates

Wall Street falls as Fed signals smaller rate cut

Barry Ritholtz weighed the news of the week negatively, finding 6 positives and 7 negatives.