The Federal Reserve’s already proven it’s more interested in equity markets than the economy.
Under the guise of the economy potentially going to suffer from a protracted trade war with China, the Fed’s James Bullard, president of the Federal Reserve Bank of St. Louis announced rate cuts were in order, and Fed Chairman Jerome Powell said on June 4, 2019, the central bank would act “as appropriate” to risks posed by a trade war with China.
Those bullish comments reversed the market’s May slide and gave investors hope that they’d see a rate cut.
Today starts the two-day long Federal Open Market Committee meeting, and investors, especially in the bond market, but increasingly in the stock market, expect at least some dovish “forward guidance” from the meeting, if not direct talk of a shift from expectations of no action to a potential cut in the future.
But the Fed can’t rescue markets if the trade war turns into a battle royale.
And markets don’t see that.
Here’s what the Fed’s doing and why it won’t be enough if the U.S. and China “go nuclear” on trade.
The Fed Is Quickly Running Out of Options
Federal Reserve officials voicing their intentions to consider rate cuts while the economy is steady, even in the face of tariff troubles, is indicative of two things: their interest in buoying markets, and their following what other central banks are doing as a means to cover their market fluffing intentions.
Most of the world’s central banks are back on rate reduction routes and applying quantitative easing measures. That’s because the economies they “manage” aren’t growing enough to cover mounting debt loads being amassed by governments and companies.
The effect of lowering rates puts their currencies under pressure and strengthens the U.S. dollar, as it becomes a “higher yielding” currency. So, foreign investors borrow in their local currencies (or wherever rates are lowest and there’s abundant money to borrow), and plow those borrowings into dollars to buy U.S. Treasuries and reap the yield differential between interest rates available in the U.S. and elsewhere.
Borrowing in a cheap currency to buy a higher yielding currency where greater interest can be collected is called a “carry trade.” Traders carry the cost of their leveraged-up positions in another government’s bonds by financing their bets using a cheap currency, often, courtesy of central bank policies.
As global central banks lowered rates, money came ashore in the U.S. and got parked in U.S. Treasuries, driving down U.S. rates and yielding a positive carry on their bets and big gains in the Treasury positions that traders amassed.
The Fed, posturing as if a rate cut was already firmly on the table, drove more investors into steeply appreciating Treasuries. The prospect of lower rates drives up bond prices and profitability on carry trades and bond bets.
Though they aren’t saying it, the Fed is also subtly trying to lower the U.S. dollar, which has been appreciating against other countries’ currencies as traders have been buying dollars in order to invest in U.S. Treasuries and equities.
All this has resulted in a huge bond market rally and U.S. equity markets rising out of their May slump.
But the truth is, there is no U.S.-China deal on the horizon. Markets are betting there will be a resolution, maybe as soon as late June when Presidents Trump and Xi encounter each other at the G20 meeting in Osaka, Japan.
What markets haven’t discounted is the possibility that the two leaders won’t meet or, even worse, could face-off and stare down each other as the only two real superpowers on the globe.
Though to main stream media, they’re trade partners, but under the table China has other alternatives if the trade war with the U.S. goes awry.
So this isn’t a “future” scenario. It’s a “now” emergency. By the Pentagon’s own estimates, China has enough missiles to wipe out every U.S. carrier strike group on the planet.
But the Pentagon has a $1.743 trillion plan to stop a Chinese sneak attack dead in its tracks.
And behind the scenes, the U.S. military has been secretly placing big bets on a new generation of defense contractors.
These small firms have been working with DARPA, our top-secret weapons maker, hunting for a way to obliterate the “carrier killer” missile.
And one of these defense contractors has cracked the code.
Play your cards right, and this defense contractor might just hand you a massive windfall.
So, enjoy the rally in the bond market and equities markets, while it lasts.
Just be ready to take profits if the economy starts to slip, as there’s no end in sight to the trade war.