03/03/2020 – I don’t get this Fed cut

The words ‘don’t fight the Fed’ are certainly true, which is why I’m a bit weirded out by how the market is playing out right now.

The Fed today cut the base rate by 50bp (half a percent) in a move that was expected, but not expected, well, today.

And the outcome is more similar to a day where an NFP number came out poorly than a 50bp…

Let’s take a look at where a few markets are trading as of time of writing.

First up, bonds ($TLT).
 

Took a decent bid on as expected when rates fall…

And the bond market is normally smarter than other markets…

Bonds tend to tell a better story.

And my view is that they are telling us that there is a risk off story here to be had – and most probably, that this Fed cut may not quite support markets in the short term as the spread between short and long dated bonds fell.

Here’s the 10/2 spread to demonstrate this.

Also note that the spread was increasing since about the 24th of Feb, when the probability of the hike started to rapidly increase.
 

I don’t know what it is, but something just feels ‘off’.

I don’t understand the 50bp cut.

There cannot be this much fear over a virus that would lead them to cut to this extent.

I’m not buying it, and seemingly, neither is the market.

Now I might be premature in saying this, but equities haven’t done much since the cut.
 

As I said, you could probably confuse it with an NFP day where the market looks like a heartbeat monitor.

Why aren’t equities flying on an even further compressed risk free rate of return?

Surely they should be higher?

Of course, much activity is conducted in the last hour of trading and we may get a monster rally in the late session…

But could it be that Fed cuts are largely anaemic now?

I reckon perhaps they’ve gotten very used to cuts providing support, but in the face of a tail risk (whether solid or simply perceived), they tend to simply not work.
 

This chart comes courtesy of @benjymaldonado.

The arrows show the prior times which the Fed has enacted an emergency rate decision.

And most of the time, the results have been dire, especially when at late cycle…

I don’t yet know what this Fed cut will amount to – no one does really.

But it does seem like a bit of a ‘shit the bed’ situation.

For those of you who aren’t well versed in English slang, it means they’ve bottled it.

Wait, that’s still an English euphemism.

Basically they’re scared.

But go back to the 2/10 spread.

What tends to happen on curve reversion?

Yup, recession.

Couple this with the Fed’s emergency cuts pretty much coinciding with recessionary conditions and you have a bit of downside confluence there for the economy.

Do we really think that the issues will stem from the US though?

I don’t.

I’ve been talking about European banks for a long time and the issues they face, and personally, I reckon this is where things will start to put real downside pressure on fundamentals and the Coronavirus ‘prepping’ could be a catalyst as productivity, lending and general economic activity is dampened…

Which would likely have an effect on European bank activity.

I also mentioned that I thought the TedSpread was too low considering the issues to do with banks cutting workforces, the extent of non-performing loans and naturally, the short term risk of the Corona Virus.

Going forward, I will be looking out for any mention of the ECB opening their swap lines with the Fed to provide liquidity.

The situation is ‘don’t fight the Fed’, and I find it hard to see how other central banks will not follow in the same actions the Fed has taken now.

Something is amiss, and I think the Coronavirus, although important, is a mere catalyst to unwinding issues that began during the post-GFC ‘recovery’.

But!

We never know.

It could be that everything is rosy and stocks get bid back heavily in the last hour of today’s session, which will give us a better idea as to how the market has taken today’s activities…

With today’s oversubscribed repo operation though, I feel that something is spooking the market, and I’ll be closely watching the submissions for the overnight repo operations through this week…

Because we can’t pretend it’s not QE really, can we?

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