A couple weeks back, I opined that the next big problem for the stock market might revolve around global central bankers changing their monetary policy tune on a coordinated basis. The idea was simple. Stocks have enjoyed the benefits of capital creation via global QE programs since the crisis ended in early 2009. The key has been that when banks print money, the cash must go somewhere. And the bottom line is that a fair amount of the freshly minted QE capital consistently found its way into the U.S. stock and bond market.
The worry is that the majority of the world's central bankers (save Japan, of course) looked to be ready to reverse course. Instead of creating capital, the plan now is for banks to begin to "normalize" their balance sheets. In English, this means the banks plan on selling trillions of dollars of the bonds and funky securities they accumulated to help keep the global banking system afloat over the last eight years.
The thinking is that although no central banker in their right mind would intentionally overwhelm or surprise the markets, a globally coordinated plan to sell bonds would become a massive headwind for the bond market. And the end result is that rates would be expected to rise - maybe a lot. Especially if the inflation that the central bankers have been striving for begins to materialize - or perhaps starts to run hot. Or if all those macro hedgies decide to front-run the Fed by doing some selling of their own.
While this outcome may sound a lot like the plan the bankers have been hatching for some time now, the problem is that the global economy was assumed to be strong when the bankers began to sell. And the big fear has been that the US Fed, the BoE, the ECB, etc., would "miss" on this element and wind up inducing economic weakness - maybe even a recession - in the process.
Recall that last month, investors had begun to worry that central banks around the world were actually turning hawkish. If one connected the dots, it appeared that this might even be a coordinated effort. For example, a string of Fed officials publicly stated they they would be in favor of hiking rates at a faster pace than currently projected by the "dot plot." In addition, Bank of England officials openly called for an increase in interest rates. And then Super Mario (aka ECB President Mario Draghi) suggested that his bank might need to scale back its monthly bond-buying program. Oh, and the Bank of Canada joined the fray by hiking rates for the first time in seven years.
The bond market definitely noticed as the yield on the U.S. 10-year climbed about a quarter of a percentage point in short order. On a chart basis, it appeared that the 10-year yield was about to break out, a move that technicians said was important. As such, it appeared that rates were on the precipice of something big.
But a funny thing happened on the way to the debacle in the bond market. Since that pivotal moment back on July 7, the worries that central bankers were suddenly turning hawkish in a coordinated fashion have fallen - in a fairly large way.
In fact, the yield on the 10-year has retraced more than half of the late-June move, having fallen from 2.4% to 2.25% over the last nine trading days. From my seat, the sudden change in the market mood is tied to the fact that the inflation data that the Fed, BoE, and ECB were banking on has been moving in the wrong direction. Instead of inflation moving above the 2% target, the data has been coming in weaker than expected. In other words, the premise for central bankers moving faster than anticipated just isn't there.
And while Yellen's bunch appeared to want to ignore the data and stick to their plan by calling the downtick in inflation "transitory," they have since come to their senses. Earlier this month, the Fed Chair acknowledged the inflation trend and said the Fed could adjust its rate policy if inflation doesn't pick up.
Then last week, the ECB also backed off what had been perceived to be a more hawkish stance by delaying any discussion of winding down its bond buying program until the fall.
So, with the central bankers apparently putting aside talk of moving rates faster than anticipated, yields have come down and the fear of the next big problem appears to have receded. And until/unless inflation starts to perk up in a meaningful way, the bears will have to back away from the panic button. Well, for now, anyway.
Thought For The Day:
If you are determined enough and willing to pay the price, you can get it done. -Mike Ditka
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the U.S. Economic Growth (Fast enough to justify valuations?)
2. The State of Earnings Growth
3. The State of Trump Administration Policies
4. The State of Fed Policy
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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