Yields on US 2 year and 5 year bonds are now at about 2.18% which is notably below the Fed funds rate of 2.50%. I've discussed the meaning of this before but I want to rehash my thoughts here. Historically, when we've seen this it's a signal that the Fed is going to cut rates in the not too distant future i.e. less than 12 months and such a thing would typically be associated with a response to perceived economic weakness and if such a rate cut happens after a campaign of rate hikes, it has typically been a signpost of the economy rolling over into a recession, but that hasn't always been the case. In mid 1995 the fed cut rates by 25bps after having hiked them continuously in 1994. At that time, the market was near all time highs and there was concerns over economic growth. After that cut the market continued to make new all time highs and never looked back for years and the fed still cut rates another 50 bps before they stopped. Here's what a headline from the NY times said back then:
"Under mounting political and economic pressure to stave off a possible recession, the Federal Reserve reduced short-term interest rates today for the first time since 1992.
Investors in the markets had been awaiting this meeting for weeks, as speculation intensified about how the Federal Reserve might respond to a string of Government statistics that showed a sharp slowdown in business activity. Some Fed officials as well as investors had begun to worry that inaction could lead to a plunge in the stock and bond markets that might make a recession more likely."
No two periods play out exactly the same but there can be rhymes. Given the pressure that Trump is putting on Powell and negative implications of tariffs at a time when there are concerns about the economy as it is, we could indeed see rate cuts sometime this year. I'm sure lots of people would call a rate cut madness when we are at record low unemployment levels and no material indications of a recession, but the bond market is saying that rate cuts are going to happen. I called Powell's last hike in December a mistake and the bond market is pretty much saying the same thing, but like in 1995, if the fed were to cut rates and thereby admit they over-tightened a bit, it doesn't necessarily spell doom. In fact, it could be opposite. Look at how the market reacted in January when the Fed simply backtracked on their plans for further hikes in 2019.
As I've said before major downturns are preceded by greed/complacency which we did not see prior to this drop in the market. You could argue that we did see such greed/complacency in early 2018 which I was pointing out, but I just don't think that it was such an extreme to have marked the end and furthermore, after the December meltdown the complacency of early 2018 got completely extinguished and has been replaced with worry. With the Uber and other "unicorn" IPOs that have recently came out, you could argue that greed/complacency was creeping back in, but as I've been pointing out repeatedly, there's been no equity inflows and a general lack of exuberance from the pundits/financial media as well. And let's not forget the fact that the market was up 18% in 4 months...at some point it had to rest otherwise we'd be on pace for a 50%+ gain in 2019 which is pretty much impossible.
I know much of what I stated is arguable. So many things are subject to one's interpretation but that's just the way the it is. The market is not an exact science. So, what is one to do? I say be pragmatic and tactical. Look for buying opportunities when there's signs of extreme negativity/capitulation and sell when you see complacency. In other words, only act when you see a perceived edge. If not, sit on your hands. But you got to be anticipatory to some degree. If you just wait for everything to be rosy you'll miss out.
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