With the Fed’s recent cut and Powell’s comments leading to more uncertainty, the bond market appears to be signaling more cuts ahead. Financial Sense Newshour spoke with Tom McClellan and Mark Chandler, for insight into current conditions.
Stocks Right on Schedule
Recent weakness in stocks isn’t likely to linger, McClellan argued. The current period is similar to the soft spot in the uptrend in 1995. The market’s reaction after the Federal Open Market Committee (FOMC) meeting is a stumbling block, he explained, and the market’s following the same script that played out in 1995.
The market tries to create panic every August of a third year in a presidential cycle and this year is no different.
“We’re seeing a scary-feeling decline right now with the Fed not doing what it's supposed to do, and with President Trump enacting tariffs that we weren't expecting,” McClellan said. “The goal of a little decline like this is to get everyone's hair on fire and make them think that the sky is falling, and the world was going to come to an end.”
Rate Cut Patterns
Typically, markets do well after a rate cut in the following six to 12 months. Based on the two-year Treasury note yield, McClellan stated, the Fed should have cut by 50 basis points. The two-year Treasury note yield would be better at determining what interest rates should be than the FOMC, he stated, because the bond market conveys messages about scarcity and over supply of money and credit more accurately than the Fed.
The two-year note yield is currently below two percent, he added, and we’re likely to see more cuts as a result. Markets will turn around sometime later in August, McClellan predicted, as nerves calm and money reenters markets.
“We should learn to listen to the useful message of the market,” McClellan said. “We may not go straight back up again out of that bottom. We may stumble around for the rest of August. August and September are typically weak seasonally, a little bit less so in the third year of our presidential term where we find ourselves now. If you have cash you’re looking to put to work, that's when you should be looking to do it.”
Tariffs Hitting Markets
Tariffs signify two things for markets. First, they indicate that the U.S .economy will be slowing. Second, they indicate that the Fed is not done cutting interest rates.
We might have already seen a near-term high for the dollar index, he added. We’ll likely spend August in a wait-and-see mode. Guidance on China’s response, the direction the ECB is going to take and more information about the direction of the economy will all make market direction clearer.
“I'm thinking that the dollar is rolling over,” McClellan said. “I’m trying to diversify out of the U.S. equity market because I think the dollar is no longer going to be a tailwind for me, and I’m looking at some of those unhedged foreign equity ETFs and open-ended funds.”
U.S. Economy Cleanest Shirt in the Dirty Laundry
Compared to Europe and Japan, the U.S. appears to be in relatively good shape, Chandler noted. With negative interest rates deepening in many parts of the world, capital is attracted to U.S. markets.
In the short term, Chandler thinks the dollar is breaking out to the upside, but he doesn’t think it will continue this trajectory. The Fed will likely keep cutting along with other countries. There are still three Fed meetings left this year. The market is pricing in two cuts and a 50 percent chance for a third, Chandler stated. Ultimately, we’re enter a phase of lower interest rates, for a longer amount of time.
“It might be an ugly contest, but the U.S. is the least ugly,” Chandler said. “The market was confused from what Powell said. I think they were disappointed that he used these words about a mid-cycle adjustment. … the market does not accept that assessment of the economy. All along, the market has been more dovish than the Federal Reserve. I think the tariffs gave the market the encouragement to press against this idea that the business cycle’s not over.”