Things have changed.
What was well in the green yesterday was back in the red today…and the Dow Jones Industrial Average has already clawed back most of the more than 200 points it was down again in early Wednesday trading.
So, things are choppy.
That goes for yields, too. We’re still well above 3% on the 10-year US treasury note, and the long bond is also still just below near-term highs.
But yields have backed up a bit this week, as the market weighs the implications of tighter money, trade wars, and innumerable other factors.
Consider, too, the latest batch of economic data.
September retail sales were up just 0.1% against an expectation of 0.6%. To make matters worse, August’s already disappointing 0.1% rise was revised lower.
And sales were actually down 0.1% if you take out volatile components like autos and gas.
Consumer spending basically drives our economy. As it was, replacement demand created by Hurricane Florence probably prevented a stronger market reaction and a much more dramatic move lower for treasury yields.
The ‘flation and the Fed
I do have a pretty good idea about the cause of this recent drama, but let’s look at recent inflation data first…
The Consumer Price Index (CPI) was up 0.1% in September, but that was well short of a forecast 0.2% gain. Year over year, CPI was up 2.3%, easing back from a 2.7% rise in August.
More important, ‘core’ prices — excluding volatile food and gas components — were also up 0.1% against an expectation of 0.2%. Core prices were up 2.2% year over year, below a 2.3% consensus forecast.
The Producer Price Index (PPI) followed up August’s 0.1% decline with an expectations-meeting 0.2% gain in September. Core wholesale prices were also up 0.2%, as expected.
So, what’s happening here?
Blame the Federal Reserve.
After keeping rates artificially low for the past 10 years, the Fed started ratcheting up the federal funds rate in December 2015. It’s also shedding assets from its balance sheet, reversing its ‘quantitative easing’ (QE) stimulus experiment.
With QE, the Fed bought long-term assets to push long-term interest rates lower during and after the Global Financial Crisis of 2008-09. It also set its overnight lending rate to 0%.
The Fed is no longer reinvesting maturing assets; this is ‘quantitative tightening’. At the same time, it’s raising the federal funds rate.
Initially, the treasury market didn’t react to the Fed’s ‘normalisation’ of monetary policy. But — after eight rate hikes, with plans for four more on the books — we’re finally starting to see a reaction.
We’ll see how long the Fed can maintain its course.
The housing market is clearly weakening. Employment seems strong, but wages still lag. Inflation hit the Fed’s 2% target but is slowing. The Trump tax cut helped prop up the economy and stimulate manufacturing, but those are probably temporary effects.
Here’s the bottom line: Higher rates will slow economic growth. It’s already happening in the housing market. Soon, they’ll cut into corporate profits.
That’s what has markets spooked.
So far, the Fed has given no indication it’ll change course.
That’s despite the fact that normalisation could trigger a major collapse.
For Harry Dent Daily