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The Art of the Deal-ish

December 2, 2018

President George Bush showed that being born into privilege doesn’t prevent you from serving.  Following the attack on Pearl Harbor, he pressed pause on his studies, enlisted in the Navy, and became the youngest naval aviator in history – just 18 years old.   James Bradley’s Flyboys is one of the most powerful books I have read and it highlights the Pacific Theater aviation battles during WWII.  One particularly dangerous raid resulted in 9 out of 10 aviators shot down, captured, tortured, and eventually killed.  The 10th, a 20 year old 2nd Lt George Bush, was plucked from the ocean up by friendlies hours later.

Bush could have used his family’s connections to avoid service, but instead he volunteered for duty.  He went on to Yale, Congress, UN Ambassador, CIA head, VP, and President.  He dedicated his life to serving the country.  I was too young to fully appreciate his presidency, so much of my early knowledge came from Dana Carvey’s SNL impersonation.  Ever the gentlemen, Bush embraced the impersonation and even poked fun of himself and Carvey.  Say what you will about “read my lips” and voodoo economics, Bush’s dedication to this country is indisputable.

I have some very good friends that are Secret Service agents. They knew Bush Sr well and have always told me he was just as gentlemanly and generous in private as he appeared to be in public.   I won’t tell you what they say about some of the others…not gonna do it…woudn’t be prudent…but Bush Sr has always been their favorite.

***Markets will be closed Wednesday to honor the passing of President Bush***

Last Week This Morning

  • 10 Year Treasury drifted lower to 2.99%
    • German bund drifted lower to 0.31%
  • 2 Year Treasury basically unchanged at 2.80%
  • LIBOR up to 2.35%, resuming its climb now that we are within 30 days of the next meeting with a hike priced in
    • Odds of a December hike actually climbed last week to 78%
  • Maybe you missed it, but apparently Jay Powell said that Fed Funds is “just below” the neutral rate
    • Less than two months ago, this same guy said Fed Funds was a “long way” from neutral
    • LIBOR has climbed 8bps in that time…I guess that was a pretty significant 8bps
  • Growing pessimism that a deal between Trump and Xi at the G20 Summit will resolve escalating trade tensions
  • Oil below $50/b, the largest monthly decline in a decade
  • GM cut 15% of its workforce
  • G20 meeting kicked off with an awkward high five between dictators, compelling Trump to spend hours convincing Xi to try out a dab-bow

 Powell Changing His Tune…Probably

The NY Fed surveys dealers each quarter in an effort to create a report card for the Federal Reserve.  This quarter’s survey resulted in the lowest grade given to the Powell-led Fed, no doubt a reaction to the hawkish comments made by Powell in early October.

On October 3rd, Powell said “Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral,” he added. “We may go past neutral, but we’re a long way from neutral at this point, probably.”  That was one week after the September rate hike.  We all know about the broad based market sell-off since then.

Last week, Powell made headlines by appearing to backtrack.  The headlines you probably read were some variation of, “Powell says Fed Funds are ‘just below’ neutral.”  While we had expected Powell to eventually change his tune about the future path of hikes, we didn’t know it would come so quickly.  The market rejoiced!

But what he really said was “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy…”.

But we also don’t think he’s gone full dove, either.  Don’t forget that in his Oct 3rd statement, he said “we may go past neutral.”   And his comments last week, while dovish, reference the “broad range of estimates” rather than a precise level.

Odds for a hike at the December meeting actually increased after his comments, up to 78% now.  This also makes sense.  If Powell is genuinely worried about a slow down in 2019 and beyond, it stands to reason that he’d squeeze in another hike now while he can still justify it.  And since the market really cares more about the path of rates than today’s rates, he can send soothing messages while still moving further away from 0%.

Bottom line – the Fed will react to incoming data.  It will be as nimble as a governmental bureaucracy can be.  It will be flexible.  The Fed minutes indicated, “monetary policy is not on a preset course.”  While Powell may not have pulled a Yellen, it was a big first step in acknowledging the Fed may need to hike less than expected.

Powell did not throw in the towel on 3 rates hikes next year, but he did send a signal that the Fed will hike less if conditions warrant…probably.

We continue to believe in 1-2 hikes next year to get to about 2.75% – 3.00%, followed by an indefinite pause.

The Art of the Deal-ish

Trump and Xi agreed to a 90 day ceasefire of sorts, with a halt on the 1/1/19 planned escalation in tariffs.  The US will continue the current 10% tariffs on $200B of Chinese instead of increasing to 25%.  In return, China agrees to an undefined but substantial amount of agriculture, industrial, and energy products to reduce the trade imbalance.  It’s not really a ceasefire because we are still imposing the existing tariffs, but at least things didn’t get worse.  Thank goodness for low bars.

While markets may breathe a temporary sigh of relief, this feels about as substantive as the whole North Korea-is-no-longer-a-nuclear-threat-and-you’re-welcome-oh-wait-we-didn’t-have-any-real-specifics-and-it-turns-out-that-crazy-dictator-isn’t-keeping-his-promise series of events.

No details about intellectual properties, currency manipulation, or state subsidies for critical industries that put the US at a disadvantage.  Color me skeptical.

One critical takeaway is that China claimed Trump agreed to respect the One China policy regarding Taiwan.  Since this is a non-negotiable deal killer for Xi, this avoids a rapid escalation.

In the near term, markets may rally on the news, but we may be revisting this discussion in February if no real progress has been made.  Trump’s hands may be tied if stocks don’t rally over the timeframe; however, if we see a Santa rally coupled with a dovish Fed, markets may move up enough for Trump to hold China’s feet to the fire in Q1 2019.

10 Year Treasury

This trade war news may be enough to push the T10 back above 3.00%, but markets on are edge right now so we don’t see a dramatic push higher.  A dovish but optimistic Powell on Wednesday may be enough to reassure the market that Powell is planning on slowing down, but not because things are bad.  It’s an odd situation where the market wants Powell to turn more dovish, but not out of fear that a recession is on the horizon.  Classic goldilocks market.

This Week

Markets closed Wednesday to honor the passing of President Bush.  No caps or swaps that day – plan accordingly.

News out of the G20 Summit and Brexit developments should dominate markets.

Data-wise, we have manufacturing data which should provide some initial glimpse into the effect of tariffs.

Job report on Friday.  If it’s a gangbuster number, do rates jump on the sense that a data-dependent Fed will revert to a more hawkish stance?  

Lots of Fed speakers as well, headlined by Powell.  He may use this as an opportunity to refine market takeaways from last week’s dovish comments.


Click to Open: The Pensford Letter PDF