Financial markets strengthened, but not primarily because the fear of tariffs had somewhat abated. The May Non-Farm Payrolls report was anything but stellar, sending a signal to the market and to the Fed that, if they wanted to get ahead of the curve, it is time to approve an interest rate cut. The U.S. Dollar also weakened during the week, falling beneath previous support levels and establishing new two-month lows.
These events were not the only signals providing pressure on the Fed. Yields on short-term T-Bills were also tumbling, well beneath the Fed’s benchmark rate. Per one analyst: “Pressure on Powell to get out ahead of things by, at the very least, signaling imminent easing at the June meeting, is growing. 2-year yields plunged 11bp on Friday morning and are on track for a fifth straight week of declines”. The following composite chart reflects job numbers and the “net” of 2-year notes and the Fed rate:
The bottom half of the diagram has been making the rounds, due to its correlation with previous Fed cuts. Goldman Sachs and David Rosenberg believe the Fed has no option but to cut: “The 2-year rates minus Fed Fund Rate is now close to -40bp and historically from this level the Fed has usually delivered a cut in the following months. Surely if Jerome Powell is a ‘markets guy’ he’ll eventually understand that when the 2-year T-note yield drifts more than 50 bps below the funds rate, nasty things tend to happen. It’s time to take the blinders off.”
While most analysts are buying into the notion of future rate cuts, Bank of America does not anticipate a move in June. They do, however, see two cuts looming down the road: “For the Fed, today’s report makes a cut more likely, and supports our view that the trade tensions will ultimately slow growth enough for the Fed to respond in September and December with cuts. The bank maintains that June is “too early” for Powell to move and says the Fed may want to wait after the G-20 meetings to get greater clarity on the current trade negotiations between China and Mexico before altering their outlook for the economy and the path of policy.”
Reading between the lines of the Bank of America comment, one month’s report does not make for a solid reason for changing course. March and April data, however, were also scaled back, and when combined with the paltry figures for February, there is definitely a weakening trend in the making for 2019. The average for the year pans out at roughly 175,000, mirroring the downward trough witnessed back at the beginning of 2017. If this trend continues, the current year is on track to hit lows not seen since 2010.
The Bureau of Labor Statistics also uses data from another Household Survey to arrive at its unemployment rate data point, which for the period remain unchanged at a 3.6%, a 50-year low. If anyone suspected that the weakening trend in the labor market was only due to recent trade tensions, the Household Survey data suggests that the recent flattening has been developing for some time, per this chart:
The “boom”, if there ever really was one, is not borne out by this depiction. The case for an economic slowdown has also been communicated by recent chaos in global bond markets. Yield curve inversions are becoming commonplace, just one more indication that momentum in the background has been receding. Central bankers have a way of tiptoeing around these obvious “forecasting errors”, acting as if surprises suddenly appeared on the radar screen. The Financial Crisis of a decade back was not foreseen until various “forecasting errors” were factored in and prior data was adjusted.
Another rate cutting exercise, however, is already in progress. India began cutting last year. Cuts in developed economies also began in New Zealand and Australia, as well, and everyone’s expectation is that the RBA in Aussieland will cut again from just under 2% to something lower.
In previous reports, the RBA had been upbeat and optimistic, stalling its cutting regimen, until it truly recognized a slowing in global demand. When it did finally cut rates, it was accompanied with this statement: “Growth in a number of our trading partners eased in the second half of 2018, and growth looks to have broadly continued at this more moderate rate into 2019. The slowing has been partly the result of a sharp slowing in global trade. This has been particularly evident in trade-exposed sectors such as manufacturing and trade-oriented economies in Asia and the euro area”.
Once again, the signs were there back in 2018. The concerns now are that, if the U.S. economy is lagging and not pulling everyone else out of a ditch, how will central bankers respond, especially those governors in the U.S. Fed. At a monetary policy conference in Chicago last Tuesday, Federal Reserve Chairman Jerome Powell spoke to many of these issues: “We do not know how or when these issues will be resolved. As always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.”
The “Fed-speak” that followed caught everyone’s attention: “In short, the proximity of interest rates to the ELB (“Effective Lower Bound”) has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance. Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future ELB spells, which we hope will be rare.”
The translation – The Fed is already of a mind that cutting rates may well be a necessity, but, this next time around, it may have to employ more QE and NIRP (Negative Interest Rate Policies). One analyst’s take was: “If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to ‘bail out’ the markets today, is much more limited than it was in 2008”.
What might we expect the impact on the USD to be going forward?
The long-term perspective for the USD Index is presented below on a weekly basis:
Similar “Rising Wedges” appear on both Daily, as well as 4-Hour, chart presentations. Such a formation generally supports from a probability standpoint a breakout that continues the trend when the pattern began to form. The “Wedge” was emblematic of the prevailing narrative that U.S. monetary policy divergences would still rule the day. The recent tumble to a Fibonacci support level factors in the possibility of a rate cut from the Fed, but, at this point, it is only speculation.
Analysts expect the next week to be “neutral”, as we wait for more information from Powell and his buddies on their inclinations headed into their next meeting. If other central banks cut or become more accommodating, then we could see a replay of 2018 when the greenback bounded back to supremacy, after hitting the low signified by the “green” box. There is still room to roam to the north, but the impact on trade, developing markets that depend heavily on commodity prices, and ultimately the global economy could be devastating. Is the world prepared for another flight of capital to “safe havens”?
Evidence of a global economic slowdown is showing up in many quarters, putting pressure on the Fed to act by cutting interest rates. As for what happens next, the forex market seems to have already baked in the potential of an adjustment in a weakening USD index. For other financial markets, the Bank of America noted: “Fed cutting cycles are not usually preceded by a sharp equity market sell off [and] in fact, the S&P 500 on average tends to rise modestly into Fed cutting cycles.”
As for when a recession might be upon us, we can expect to see a raft of articles with predictions attached to appear shortly in the financial press. The ones that have already placed their stake in the sand are saying anywhere from 26% to 40%, as the probability of a recession in the next twelve months. A recent survey of CFOs, the fellows that react first to pull back the corporate reins of commerce, revealed that 67% of the group felt the same thing. Whatever the case may be, our central banks do not have a full keg of dry powder to help us recover the next business slowdown. Things could get extra rocky.