Stocks Await Fed Minutes Which Could Invert the Yield Curve

Stocks Await Fed Minutes - Mostly Flat Ahead Of Fed Minutes

Stocks Await Fed Minutes and stay flat with anticipation. They have declined slightly from their record high. Mostly because they were overbought. And also because investors questioned how dovish the Fed would be after the solid jobs report.

If I was a Fed member making discussions that were going to be in the Minutes, I wouldn’t bend over backwards to cut rates just to appease stocks. Especially since the market has rallied exceptionally this year.

If stocks were up 50% year to date, would the Fed still worry about stocks falling? I’m not saying the Fed shouldn’t care about stocks. But the possibility of a 5% decline in stocks shouldn’t affect policy.

Only way stocks will fall over 10% is if there is a real economic decline. At that point, the Fed would act to ease the blow by cutting rates sharply.

Stocks were mostly flat ahead of the Fed Minutes on Tuesday

Stocks Await Fed Minutes - S&P 500 increased 0.12%, Russell 2000 was up 8 basis points, and Nasdaq was up 0.54%. I think the market is set up to be disappointed by anything the Fed does or says in the future.

Philadelphia Fed’s President Patrick Harker, who isn’t a voting member, stated he doesn’t see a compelling reason to change rates. It’s a fair perspective. Fed’s goals to have a strong labor market and stable prices have been achieved.

You have to wonder how long the correction in stocks in Q4 2018 and the possibility of a worsening trade war can affect Fed policy. Especially without there being any real signs of a recession or weakness in the labor market. Fed’s obvious fear is if it isn’t dovish, stocks will fall 20% again.

Stocks Await Fed Minutes - 87% Chance The Fed Cuts Rates On July 31st

There is now only a 1.8% chance the Fed cuts rates by 50 basis points in July. That would be such harsh action. Especially given how close the Fed funds rate is to the zero bound. And also how solid the labor market is, as well as how elevated stocks are.

To those who say the Fed can cut rates below 0%, maybe it can, but that shouldn’t be the plan.

Ultimately, regardless of what anyone thinks this rate cut, it is likely going to happen. There is a 100% chance of a cut. The rate hike in December that pushed stocks lower will be rescinded.

When the market expects an action 21 days in advance of a meeting, there is an 87% chance of that action occurring. As we get closer to the meeting, the odds increase.

Only catalyst that could cause the Fed to not cut rates would be a trade deal. Larry Kudlow recently stated a trade deal may never happen. He’s been bullish on the possibility of a trade deal, so that statement has weight.

There is zero evidence of a trade deal occurring this month. But it’s not impossible that at any time both China and America can rescind their tariffs. Especially if negotiations are going well.

Specifics Of Tuesday’s Action

Stocks Await Fed Minutes - Consumer discretionary sector hit an all-time closing high on Tuesday as it was up 0.33%. Amazon stock had a big 1.84% gain. It drove the Nasdaq the consumer discretionary sector higher.

Amazon has made a new high on the year and is closing in on its record high. It is at $1,988 and its record high is $2,040. Biggest losers on Tuesday were the consumer staples and materials sectors which fell 0.58% and 1.01%. Staples sector was hurt by PepsiCo which saw its stock fall 0.62% on solid earnings.

PepsiCo reported $1.54 in EPS which beat estimates by 4 cents. Its EPS is down 4.35% from last year. Revenues also beat estimates as they were $16.449 billion which was above the consensus of $16.426 billion.

Revenue growth in its North American business was helped by its Starbucks coffee drinks and water. Its new products Mtn Dew Game Fuel and Bubly are doing well as the company diversifies away from its traditional soda business.

Including PepsiCo’s results, the first 22 S&P 500 firms have had sales growth of 2.8% and EPS growth of 4.67%. 15 of the 22 firms have beaten EPS estimates. That is a 68% rate. The table below shows all the reports so far.

Best sectors on Tuesday were real estate and financials.

Stocks Await Fed Minutes - Financials have been helped by the recent rise in yields. They also like that the Fed funds futures market is no longer pricing in a 50 basis point cut this year.

However, they have been hurt by the flattening of the yield curve. 10 year yield has recently risen to 2.07%. 2 year yield is at 1.91%. That’s a 16 basis point gap.

That's about 7 points above the low for the cycle which was hit in December. A less dovish Fed Minutes could flatten the curve further. I will follow the 2 year yield to see how the market interprets the Minutes.

Stocks Await Fed Minutes - Recession Soon?

Talk of the town is how the NY Fed’s recession probability index has risen to 32.88%. That’s important because this rate has been consistent with recessions since the late 1960s.

Only false signal in the chart below that dates back to the late 1950s is the signal in the late 1960s. The one where the reading got to above 40% without a recession.

This indicator is being given far too much weight. Anything that signals a recession gets a lot of attention. This signal is based on the treasury spread.

If the Fed cuts rates, much of the curve will be normalized. This isn’t a traditional inversion. It won’t be until the 10 year yield falls below the 2 year yield.

I’m not ruling out a recession. But I am not using this indicator to conclude that a recession will definitely occur in the next 12 months. We still need to see more weakness from other reports such as jobless claims.

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