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Record highs on Fed dovishness and trade optimism

JUN. 25, 2019
  • Equity markets rallied to all-time highs on incremental dovishness from the Federal Reserve and renewed optimism on a China trade deal. The S&P 500 Index rose for the third-straight week, rising 7% in June and reversing the 7% decline in May. With an 18% jump year-to-date, this is the best start to a year since 1997. Virtually all asset classes have participated, including equities, bonds, gold and oil. All major regional equity indexes and domestic style boxes are more than 10% higher for the year.
  • The FOMC has opened the door to rate cuts in response to the low level of inflation and uncertain economic environment. Though the median dot on the plot did not change, seven members see two cuts this year, one sees a single cut. Eight officials see rates unchanged this year and one member called for a 0.25% hike. Chair Powell highlighted the downside risks and sees a stronger case for accommodation. Investors reacted to a clearly more dovish FOMC, with equity markets rallying to all-time highs. The dollar has sharply reversed from its recent high, falling to near the low of the year. The 10-year yield briefly dropped below 2% for the first time since before the 2016 election before recovering modestly. The Fed futures curve embeds 100% odds of at least one cut in July, with a one-in-four chance of two cuts. For the year, the curve shows a 63% chance of three or more cuts, which is notably more dovish than the Fed’s guidance.
  • Optimism continues to grow for an agreement between the U.S. and China with Vice Minister Wang saying both sides need to compromise if they are to reach a deal when Trump and Xi meet on the sidelines of G20 later this week. Talks between trade officials are scheduled for Tuesday, three days before the scheduled Trump-Xi meeting at the G-20. While expectations for a deal are muted, it could reset the tone and set parameters for future discussions.
  • Iran: Geopolitical tensions remain elevated following the attack on two tankers and the downing of a surveillance drone near the Straight of Hormuz. While a military response has been avoided, President Trump stated he would impose fresh sanctions on Iran. Officials in Tehran dispute the details on the tanker attack and claim the drone was shot down over Iranian airspace and threatened to respond firmly to any threat. Crude oil prices spiked in response, with WTI up 13% in two weeks.
  • Sentiment: Despite the equity markets touching all-time highs, individual and institutional investor sentiment reflects pessimism. The American Association of Individual Investors Sentiment Survey shows more bears (32%) than bulls (30%.) The BofA Merrill Lynch survey of fund managers showing a jump in cash since the 2011 debt ceiling crisis and the lowest allocation of equities versus bonds since the financial crisis. There was a record decline in global growth expectations and a record reading that the global economy is in “late cycle.”

What to Watch:

  • Trade talks will drive the headlines this week as the G-20 meeting begins Friday in Japan. Economic data includes consumer confidence and new home sales on Tuesday, durable goods on Wednesday, revised first-quarter GDP and pending home sales on Thursday, and PCE deflator, personal income and spending and consumer sentiment on Friday.

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