Thanks in no small part to rampant expectations for Fed cuts, US equities were on track Monday afternoon for one of their more impressive five-day rallies in years.
Ostensibly, the Trump administration’s decision to call off planned tariffs on Mexico contributed to the risk-on tone to start the new week. That’s ironic, because it was precisely the fear of those tariffs (and the read-through for trade talks with Europe and China) that helped cement the case for preemptive rate cuts in the minds of many market participants.
Although there’s something of a “false optic” going on in rates, there’s no question that global recession concerns (heightened by the prospect of an all-out trade war) have been the driving force behind rate cut bets and plunging bond yields. On Monday, 10-year yields in the US rose 6bp and are up more than 10bp from the lows, as the market tries to decide whether bonds have overshot.
If you ask UBS’s Chirag Mirani, yields should go higher in the US. For Mirani, the market is underpricing the chances of a resolution to the US-China dispute and the bank believes there’s scope for meaningful progress at the G20.
Asked on Monday morning during his extraordinary CNBC interview about the prospect of President Xi refusing to meet later this month, Trump indicated that would trigger the next round of tariffs.
UBS, like Goldman, hasn’t adopted rate cuts as their base case in 2019, and expects the median dot to remain unchanged this month.
For their part, BNP doesn’t agree. In a note dated Monday, the bank joins JPMorgan, Barclays, BofA, Credits Suisse and others, in revising their Fed call. “We now expect the Fed to implement two insurance-style rate cuts in Q3, at its 31 July and 18 September meetings”, the bank writes.
As far as the June meeting, BNP expects the Fed to “signal greater readiness for an accommodative shift, likely through pointing to rising downside risks and modifying its commitment to patient policy in the meeting statement.”
The bank does not agree with the market when it comes to what happens after a hypothetical September cut, though. “The market continues to price in easing, by about an additional half-cut by the end of this year and a cumulative 100bp by year-end 2020 [while] we see the cutting cycle ending after September, with precautionary cuts helping to shore up markets and stabilize the economy by Q4”, the bank says.
Fingers crossed on that “stabilization” of the economy by the end of the year bit. That clearly depends on the evolution of the trade war. The bank is also cutting their growth forecast for the US but does note that “the sky isn’t falling (yet)”.
When it comes to the projected insurance cuts, the bank views them “as similar to the ones made in July and December 1995 and November 2002, which were implemented to get ahead possible growth deterioration amidst rising downside risks and soft inflation.” Here’s a chart that attempts to model the impact of a further China tariff escalation with 50bp of Fed cuts and without:
That, right there, is one reason the president is so keen on the Fed helping to “level the table” with the PBoC, as he put in on Monday.
Finally, BNP underscores the main risk (and if you’re getting tired of hearing this reiterated, you might ask yourself whether the fact that everyone seems to be so concerned about it is evidence of its veracity).
“Our somewhat benign take on the fundamental outlook coupled with some relief in equity markets if the Fed does make an insurance cut may ironically embolden the President to deploy the hammer of tariffs on an ever wider list of trading partners”, BNP warns, in a section called “why we might be wrong.”
The bank then somewhat dryly notes that “POTUS actually does believe that tariffs result in a net positive for the US economy.”
Here sure does, folks. He sure does. And that should scare you to death.