“Dow Jones has best week of the year!”, an elated Donald Trump tweeted, at 5:43 PM on Friday evening, after the closing bell sounded on what was, in fact, a stellar week for US equities.
One thing’s for sure, it wasn’t the strength of the MAGA economy that had stocks racing more than 4% higher this week. ISM manufacturing printed the lowest of the Trump presidency, we got the worst ADP report in more than nine years and the May jobs report was a “big league” disappointment.
Paradoxically (or not, because this is a dynamic that is familiar to most traders) it was that weakness in the US economy that helped equities. Until recently, the case for Fed cuts revolved mostly (if not entirely) around stubbornly low inflation and a worsening outlook for the global (i.e., ex-US) economy. Trump’s incessant badgering notwithstanding, the Powell Fed has been reluctant to countenance the idea of rate cuts in the face of a domestic economy that, as of Q1 anyway, was still growing at a 3% clip with unemployment at a five-decade low.
Now, the US data appears to be rolling over (finally). That, along with the latest escalations in the trade war, is making a solid case for “insurance” cuts.
“The recent series of weak economic data releases has increased investor expectations that the Fed will soon ease policy”, Goldman wrote Friday evening. “Many investors expect the Fed will cut rates in response to a slowdown in the pace of economic growth and intensifying trade tensions”, David Kostin said, stating the obvious.
So, the “bad news is good news” days are back – and with a vengeance.
“I feel four years younger today. It looks like 2015 all over again”, Deutsche Bank’s Aleksandar Kocic quipped, in a brief note to clients.
“We are back to the all too familiar bad-news-is-good-news regime [and] this is a major relapse”, he continued, harkening back to the taper tantrum days, when the market’s reluctance to accept the notion of Fed normalization embedded the “bad news is good news” mentality into the market’s collective consciousness.
As Kocic reminds you, following the taper tantrum, “equity (and credit) performance showed systematic negative correlations to payroll numbers”. The chart above shows a regression of S&P daily return versus NFP on payrolls days from mid-2013 to mid-2015.
“[Friday’s] performance appears as an outlier even by [2013-2015] standards”, Kocic remarked.
If you’re wondering whether there’s any historical precedent for futures discounting a cut a month ahead of a scheduled FOMC meeting only to have the Fed not cut, the answer is “yes”, but not much.
“February 1990 and February 1992 stand out as two experiences where the market unwound its earlier expectation for a cut by the time of the meeting”, Goldman notes, before reminding you that “in both these cases the S&P 500 fell during the month ahead of the meeting, -5% in 1990 and -1% in 1992.”
As Kostin goes on to point out, “since 1988, on 13 occasions the futures market expected a cut in the funds rate the day prior to a scheduled FOMC meeting. The Fed cut rates in all 13 instances.”
While they may get a pass if they don’t cut this month, current market pricing and historical precedent suggest that if the Fed doesn’t intend to start moving in July and keep on movin’ thereafter on the way to three cuts, they’ll need to start pushing back against market expectations now, or risk “deliver[ing] a hawkish disappointment”, as Goldman puts it.
And so, in the meantime, hope for more data disappointments, I suppose. “Make bad news great again!”