MorningWord 6/3/16: Less Than Zero

by Dan June 3, 2016 9:41 am • Commentary

If the May jobs data had come in hot this morning, it would have provided coverage for the U.S. Fed to pull the trigger on their second rate hike in 10 years (their first since December) at their upcoming June or July Fed meeting. With that, the knee-jerk reaction would have likely been a decline is U.S. stocks.

We saw the exact opposite of that. This morning’s very weak May print coupled with a large downward revision to April means a June hike it totally off the table and any continuation of this trend next month and it probably takes a summer hike off the table entirely.

Fed Fund futures are now pricing a 4% probability of a hike in June (down from 34% on May 25th, and only a 35% probability of a hike at their July 27th meeting.

From Bloomberg
From Bloomberg

I’ll remind you of some Goldman Sachs research that I posted on Wednesday morning (via 

History suggests that some 90 percent of rate hikes over the past 25 years already were highly anticipated by the market, with at least a 70 percent chance discounted in, according to research Goldman Sachs released this week.


Goldman found that going back to 1994, 90 percent of the 31 rate hikes were priced in at least 50 percent 30 days ahead of the FOMC meeting. Getting closer to the meeting, the median hike was 95 percent priced in, with only a few deviations, such as from the Alan Greenspan Fed in March 1997 and November 1999.

It’s been my view that the Fed will not raise rates this Summer, and possibly not for the balance of the year. That’s one of the main reasons I prefer defensive positioning via long U.S. Treasury Bonds, especially while investors last month started to price in a higher probability of summer hikes (Must Yield to Fedestrians – TLT).

SO this morning, bad economic news, for now being viewed as bad for risk assets, which in my mind makes perfect sense as a continuation of this trend in the U.S. would very likely be coupled with increasingly dour data in Europe and emerging markets which would then start to increase the odds of a recession here at a time where corporate profits are already in a recession.  And the big risk is that a global recession would come at a time when the the U.S. Federal Reserve had exhausted all traditional means of monetary stimulus at a time when more than $10 trillion of sovereign debt around the global is already below the zero interest bound. I’ll also remind you that in the last two instances when the S&P 500 (SPX) topped out prior to a recession in 2000 and 2007, the Fed Funds rate was at 5%, well above the current 25 bps today:

Fed Funds Rate vs SPX since 1999 from Bloomberg
Fed Funds Rate vs SPX since 1999 from Bloomberg

The obvious risk for investors is one that we have hit on numerous occasions since last summer, and well summarized by the WSJ’s John Hilsenrath when he suggested on August 17th, 2015 that the:


So some sort of crisis is coming. A U.S. recession is in the offing at some point likely prior to a full blown crisis. And with rates where they are, the Fed’s only option is to go from unconventional to just making stuff up.

The trend is not worth fighting, Treasury Yields still seem like they are going to zero and possibly beyond:

U.S. 10 year Treasury Yield, 20 year chart from Bloomberg
U.S. 10 year Treasury Yield, 20 year chart from Bloomberg

So go get yourself some defensive, yield where it exists in U.S. telcos, utilities etc. And stay tuned for ways to do that with defined risk as that will remain a theme here on RiskReversal.