Jun 10, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Authorities say they will move forward with a proposed law that would let Beijing take people to stand trial in mainland China despite weekend protests reportedly of more than 1 million people against it. (Reuters)
  • Raytheon announced it will combine with aerospace giant United Technologies in an all-stock merger to create the 2nd-largest defense and aerospace company in the U.S., trailing only Boeing. (NBC News)
  • The Mexican peso rose more than 2% against the dollar after President Trump said late Friday that plans for a 5% tariff on all Mexican goods had been "indefinitely suspended." (Bloomberg)
1 big thing: The problem with the "Powell put"

Illustration: Aïda Amer/Axios

When Fed chair Jerome Powell said Tuesday that the Fed would "act as appropriate to sustain the expansion" traders took it as the latest confirmation of the Powell put — the notion that Powell and the Fed are prepared to lower interest rates and stimulate the economy if stock prices fall too far.

In a strong economy like we've got now a few interest rate cuts are likely enough to keep confidence high and business activity chugging. But Friday's jobs numbers, coupled with last week's PMI readings show that things may be starting to turn.

  • Add to that the growing likelihood of recessions in Europe and Japan and the fact that policymakers there have little ammo left to fight one.
  • And U.S. interest rates are barely above the rate of inflation.

This could be a problem that 50 basis points of interest rate cuts (or even 75) isn't going to solve.

What they're saying: "The market overestimates the power of central banks and stimulus," Zhiwei Ren, managing director and portfolio manager at Penn Mutual, told Axios in March.

The problem with the economy today isn't on the supply side, Ren said. The market isn't lacking liquidity and businesses broadly aren't having trouble obtaining credit — those are the issues monetary policy is designed to tackle. The problem today is on the demand side.

  • Central banks "can pump as much money as they want but liquidity isn't flowing into the real economy," Ren added. "No matter how much credit you provide, if nobody comes to borrow that's a liquidity trap."

On the positive side: The U.S. has at least built in some breathing room by raising rates from zero, beginning in 2015, and reducing the value of the Fed's bond holdings from a record $4.5 trillion.

But, but, but: The Fed continues to purchase trillions in U.S. Treasuries and mortgage-backed securities.

  • And while the impact of the Trump tax cut and spending increases is expected to fade this year, the U.S. government is still taking in far less revenue and spending far more than it historically has — another form of stimulus the market is already receiving.

The bottom line: We're in year 11 of the monetary easing experiment and it's become pretty clear the goal of weaning the economy off its free money medicine isn't working as planned.

  • One has to wonder if a Powell put is really something the market should be excited about.
Bonus thought bubble

Our bonus thought bubble, from Axios' business managing editor Jennifer Kingson: "It's interesting that the markets all move with Pavlovian predictability in response to these various indicators, when there's no longer such strong evidence that cause leads to effect the way it once did, or, at least, the way it was once seen to have done. And the power of the levers Powell wields would seem to be quite depleted."

2. The shrinking U.S. yield premium
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Data: U.S. Department of the Treasury, Investing.com; Chart: Andrew Witherspoon/Axios

Even as foreign governments like China have reduced their holdings of U.S. Treasuries recently, appetite has continued to push prices up and yields down, with the benchmark 10-year note yielding its lowest since 2017.

One major theme boosting U.S. bond buying has been that Treasuries hold significantly higher yields than comparable government bonds from developed market peers like Canada, Japan and the eurozone. While the U.S. remains the best house in a bad neighborhood, that yield premium is compressing.

What's happening: The differential between U.S. and German yields reached its highest level in modern history in November, but has fallen precipitously since then, notes Bannockburn Global Forex chief market strategist Marc Chandler. Against other countries, yield differentials that were extraordinary have been whittled down from all-time or decade-long highs to cycle lows.

  • U.S. 2-year yields were 85 basis points above Canadian yields in February, the most since the financial crisis, but have fallen to 45 basis points.
  • The 2-year was more than 100 basis points higher than comparable Australian yields just 2 weeks ago and is now just 75 basis points higher.

Why it matters: Market strategists are betting the bond market has further room to run, with rates continuing to fall, but if the U.S. yield premium vanishes, foreign buyers could do so as well.

  • That may also be bad news for the U.S. dollar, as lower bond yields make currencies less attractive to foreign buyers, but could be good news for U.S. multi-national firms who have been struggling with the dollar's prolonged strength. 
3. FedEx picks sides in Walmart's battle with Amazon

FedEx announced it would not renew its contract to provide express shipping service for Amazon in the U.S., passing up on $850 million in annual revenue.

Why you'll hear about this again: As Amazon muscles into FedEx's turf on shipping — with its online trucking platform already undercutting the the industry's big players' average shipping rates by up to 33%, according to FreightWaves — the shipping giant sent a signal that it was getting behind Amazon's biggest rivals.

  • If Amazon wants to roll out Uber for package delivery shipping (its Flex delivery service is a gig economy-style program the company has been offering employees $10,000 to leave their Amazon jobs for), FedEx isn't going to caught flat-footed the way the taxi industry was.

Shots fired: "FedEx has already built out the network and capacity to serve thousands of retailers in the e-commerce space, including brands such as Target, Walgreens and Walmart," a FedEx spokeswoman said in a statement Friday.

4. Confirmed: It's better to have rich parents than be smart

A recent report from the Georgetown Center on Education and the Workforce (CEW) finds that there is a correct answer to the often posed hypothetical of being born with a big brain or a big bank account.

In "Born to Win, Schooled to Lose," researchers found that being born "affluent" but dim carries a 7 in 10 chance of reaching a high socioeconomic status as an adult, while being born intelligent but "disadvantaged" means just a 3-in-10 shot.

Details: "The study found that a kindergarten student from the bottom 25% of socioeconomic status with test scores from the top 25% of students has a 31% chance of earning a college education and working a job that pays at least $35,000 by the time they are 25, and at least $45,000 by the time they are 35," CNBC's Abigail Hess reports.

  • "A kindergarten student from the top 25% of socioeconomic status with test scores from the bottom 25% of students had a 71% chance of achieving the same achievements," Hess writes.

How they did it: Researchers analyzed data from the National Center for Education Statistics (NCES), tracing students from kindergarten to adulthood, assessing how they did on standardized math tests.

5. Young women want cheap engagement rings
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Reproduced from a TD Ameritrade report; Chart: Axios Visuals

TD Ameritrade found that younger generations have a very different outlook on how much an engagement ring should cost than their parents.

Perhaps most surprisingly (to those of you with outdated gender biases, at least), women consistently reported lower expectations of engagement ring costs than men.

Dion Rabouin