The Fed will have to begin cutting the Fed funds rate sooner, but for reasons that have little to do with a slowing domestic economy. As global bond yields continue to sink, the Fed will have to follow suit – even if the Fed can afford to remain relatively tight. I do not see a recession on the horizon and the domestic economy remains relatively sound. If the Fed does embark on a much more aggressively dovish policy, I have to believe that the asset markets will rise more than what many are anticipating.
Janet Yellen, the former chair of the Federal Reserve, said Monday the recent triggering of a recession indicator in the U.S. bond markets could signal the need for an interest rate cut and not a prolonged economic downturn.
Yellen was asked at a Hong Kong conference about the yield curve inversion and whether it signals a looming downturn.
“My own answer is no, I don’t see it as a signal of recession,” Yellen said during a question and answer session at the Credit Suisse Asian Investment Conference.
“In contrast to times past, there’s a tendency now for the yield curve to be very flat,” she said, adding that it’s now easier for it to invert — which traditionally meant investors had become concerned about a future downturn.
“And in fact it might signal that the Fed would at some point need to cut rates, but it certainly doesn’t signal that this is a set of developments that would necessarily cause a recession,” Yellen added.
I have been observing that the Fed seems to be much more preoccupied with what is going on in the rest of the world than in the past. The central banks are coordinating policy in an unprecedented fashion. I am concerned that the Fed will attempt to placate the outside world at the expense of the domestic economy. This is why I have to conclude that dollar-based asset prices of all kinds are going to climb higher and continue outperforming over time.
First, I completely agree with Janet Yellen’s assessment. There is no domestic recession on the horizon. Recall, that the U.S. Fed anticipates 2019 domestic GDP growth of 2.1%. While this was a drop of 0.2% from the prior Fed estimate of 2.3%, this is hardly a time to contemplate a recession. So, imagine what lower short-term rates will mean to the prices of assets.
Second, I predict that the Fed will have to begin to cut the Fed funds rate soon, because the rest of the global economy is sinking and the U.S. dollar has remained persistently strong. As the days go by, the global pool of negative-yielding sovereign debt continues to grow and the total amount now tops $10 trillion. The U.S. offers too much relative yield.
Third, the domestic economy will continue to outperform and if the Fed cuts, look for economic output here to continue to remain relatively higher.
Fourth, I find it difficult to comprehend that so many market analysts are anticipating an upcoming recession by looking at the sharp drop in the 10 year UST. Bearishness is very high right now. Lower rates are going to juice the U.S. economy at the worst time. Many market participants will be caught off guard.
Fifth, do not get caught up with yield inversions. It has been clear that there has been official intervention with longer-dated Treasuries. The long end of the yield curve fell in direct relation to the Fed’s change in policy stance. I cannot overestimate how large of a change the Fed has undertaken just since late December. Though the 10-year UST yield began to fall into the stock swoon of late 2018, the yield continued to sink as stocks recovered. This shows us the power of the Fed’s about-face. Bond traders are already buying in anticipation of what is to come.
Sixth, I no longer hear talk of asset bubbles by the monetary authorities. I have to believe that on some level, they are going to welcome higher asset prices. Higher asset prices justify higher debt levels, and this will work hand-in-glove with the central banks as they once again ramp up their asset purchases.
If we just focused on the United States economy, the Fed has room to remain tighter, but given the relative strength of the U.S. dollar and the yield differentials between U.S. sovereign debt and other nation’s, the Fed understands that the world is awash with too much government debt issuance and the central banks need to step up their coordination for more rounds of QE and monetary stimulus. Those who believe that the PBOC is not participating are seriously misguided. Its balance sheet continues to grow as well and foreign reserves remain at high levels.
I know I am going out on a limb, especially in the face of such bearishness, but I still see higher real estate numbers in the wheelhouse of the U.S. and the lower rates are providing an auspicious tailwind. Short of a nuclear war, I don’t see this changing. Of course, we may see some short-term drops, but I expect higher prices for many things and the government will step in to “help” those who have gotten left in the dust.