For the third week in a row, we are publishing our thoughts on central bank activity. We try our best to diversify topics in these notes, but as we’ve continued to highlight (and with last week proving our thesis correct), it is central banks that have become the main driver of financial market behavior in the current environment.
All three major central banks around the world (Bank of Japan, European Central Bank and Federal Reserve) met or spoke publicly last week. And even though no explicit policy action was taken, their words were more than enough to move markets. In all three cases, the leaders of the institutions articulated that they stand ready to take additional easing action should it be necessary to support their economies. These words provided a boost to stocks, a boost to bonds…a boost to pretty much everything.
For the Fed specifically, the committee expects to cut interest rates by 0.50% in the coming quarters. This expectation affirmed what the bond market has been pricing-in for the last several weeks. It also gave a boost to equities and other risk assets, as the action shows the FOMC is committed to keeping this economy growing in whatever way it can.
For bonds, short-term interest rates (think 2-year bonds) fell significantly while longer-term rates (10+ years) rose slightly. This “steepening” of the yield curve tells us that the rally we’ve seen in long-term bond yields in 2019 is closer to its end than its beginning, and that we are likely to settle in to a range bound trading environment from here.
For risk assets (think equities and credit products), the story is not so simple. Fundamentals are weakening, and the question becomes whether assurances for future monetary policy easing will be enough to halt the slowdown. That is, will fed easing later this year be too little, too late to arrest weakening in US and global economies? The next round of economic data hits in early July and is expected to be relatively tepid. We will hear from corporate America during Q2 earnings season. And let’s not forget the U.S./China meeting at the G20 next week.
So, while the picture for bonds is seemingly straightforward, the situation for risk assets is fluid. Several of our risk bets have paid off (short-BBB corps, natural gas pre-pays, housing and our taxable muni overweight), and we have dry powder. We are staying conservative, liquid and ready to act on any opportunity that comes about as politicians and policymakers attempt to thread the needle.