Setting the Stage

These next two weeks are pivotal for the global economy. The Federal Reserve’s (Fed) next policy meeting starts June 18 with a policy announcement due June 19. In the following week, global leaders will convene at the G-20 Summit in Japan, and we’ll likely get clues on the state of the U.S.-China trade talks.

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Stocks and Fed Rate Cuts

A potential rate cut may give stocks a lift. Stocks have benefited recently from increasing hopes of a Federal Reserve (Fed) rate cut, pulling the S&P 500 Index back to within 2% of its record high set on April 30, as of June 14. On June 4 Fed Chair Jay Powell signaled a possible cut by saying “we will act as appropriate to sustain the expansion,” and since then, as of Friday, June 14, 2019, the S&P 500 is up 5.4%. The central bank’s verbal pivot, partly an acknowledgement that they must be ready to offset trade tensions, has pushed the odds of a rate cut in July from roughly 60% to 86%, based on the fed fund futures market. So what might a cut mean for stocks?

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A Record-Long Expansion

The economic expansion just turned 10 years old, tied for the longest on record, according to the National Bureau of Economic Research. It’s only fitting with this milestone that economic skepticism is peaking once again. Many investors, especially in the bond market, have been bracing for an economic slowdown and calling for Federal Reserve (Fed) intervention as global trade disputes rattle financial markets [Figure 1].

The trade situation is unnerving, and we’re aware an escalation could eventually wear on an aging expansion. It’s important to remember, though, that with sound fundamentals and a measured Fed, the U.S. economy has navigated several global crises in this cycle. We think both supportive factors are still in place.

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Bull Market For Policy Uncertainty

Last week stocks enjoyed their best week since November 2018 despite rampant policy uncertainty. Policy uncertainty remains high, particularly around trade, but you wouldn’t know it from last week’s stock market rally, which jumped 4.4% on increasing hopes for Federal Reserve (Fed) rate cuts. That jump brought the S&P 500 Index to within 2.5% of its April 30 record high. However, that doesn’t mean stocks are in the clear as the trade conflict with China continues.

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Bond Markets’ Signal To Stocks

Should stock investors be concerned about the signals coming from the bond market? Trade tensions were the biggest reason stocks suffered their first down month of 2019 in May, but worrisome signals from the bond market contributed. This week we look at what the bond market signals mean for the stock market and examine the disconnect between the bond market and economic and stock market fundamentals.

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The Baffling Bond Market

The bond market has been baffling recently. While U.S. stocks surged earlier this year, the 10-year Treasury yield quietly crept lower, puzzling market participants as the typical relationship between stocks and bonds (higher stock prices, higher yields) broke down at a rapid pace.

Then, the alligator jaws snapped shut. The S&P 500 Index has dropped about 6% since reaching a record high on April 30, and the decline of long-term government bond yields across the globe picked up speed [Figure 1]. Last week, the 10-year yield posted its biggest weekly drop in over four years to close at a 20-month low of 2.12%, and parts of the yield curve have flipped back into inverted territory (long-term rates falling below short-term rates).

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