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Late 2018, we issued a bullish United States Treasuries call (lower interest rates) for full year 2019, with expectations for two 25bps cuts by the Fed by end of 2019.
This call was made at a time when the general market is calling for up to three 25bps hikes by the Fed for 2019, which we had reasoned then was impossible given the on going trade war and impending US Corporate debt crisis from outflows in High Yield and Leverage Loans.
New readers can refer to the summarised call on our 2018 year in review post in the link below.
The market have validated our prediction this week, with the CME Fed Funds Futures now predicting a 90% certainty for two 25bps rate cuts into December 2019 this week after Powell indicated he is open to rate cuts if necessary.(We still can't believe he called for this when the S&P500 is trading at 2750 levels, which tell us much about his desperation for defending the market at 2700 levels, is absolutely absurd compared to previous Fed Puts levels. We touch on this issue in the writings below)
Call it pressure by Trump politically given further aggravation of the US-China trade war, bulls can't deny that global economic data have deteriorated further as we move into H2 2019. This is also met by weaker PPI globally and falling CRB index.
US equities remain supported by Trade War recovery hopes, and now the Fed Put while Asian equities have suffered in recent weeks. As we have always called for a prolong trade war given the aim of the United States is to prevent China from taking No.1 spot globally, while the 25% tarries on Chinese products will have profound impact on the Chinese economy given how much impact 10% have done to the Chinese economy.
We remain negative equities globally, while the recent weakness in US equities have again reignite the outflows in High Yield bonds. HYG saw some recovery in the recent week on lower global interest rates, however we expect a resumption of the outflows as a slowing global economy likely continue a cap on global equity prices.
We think the major reason why the Fed is doing everything it could to support the equity market, is the link of equity prices and confidences to the value of HYG bonds. HYG and Triple B rated US issues in our view are strongly supported by Fed policy to lift equity prices by which is the biggest bubble resulted form modern day monetary policy experiments. The lifting of the Fed put levels clearly shows the Fed intentions.
As below charts shows the amount of US Corporate debt along with suppressed yields resulting from QE policies.
Given where the S&P500 is trading, we expect the Fed to only move into cutting rates should we move at least 5% lower from current levels. A big question if is equities right to trade higher on lower rates given better valuation basis, or are UST right to trade bid resulting in lower rates and forcing the Fed to follow through to market expectations.
Given a 5% bounce from the lows for the S&P500 to close at 2873, the answer seem to be if we can break the all time high zone of 2950 to kick the Triple B cliff implosion further down the road, or face truthmagaddon given the Fed have in recent meetings acknowledged the risk to corporate bond borrowing risk in an event of a major downturn globally, and the close correlation between US Equity prices and HYG Index.
The chart below shows purple line (HYG) against S&P500.
Given where global economic data is trending in the past 6 months, we remain bearish on global equities, and should the HYG index trade under 80 in an event of stress on US equities and implosion of the US Triple B corporate debt, we expect the Fed to extend their rate cuts commitment in 2020 by another four 25bps cuts.
Conclusion : We do not expect global equities to extend much further from their all time highs, while slower momentum from weaker economic data and continued outflows from High Yield Bonds and Leveraged Loans will further poise a problem to global equity prices and force the Federal Reserve to extend cuts into 2020.
Key support levels to watch : S&P500 Index @ 2700 , HYG Index @ 80