Fed Flips Extends Bull, But How Long?
The Federal Reserve has now reduced its key interest rate—the Fed Funds rate—for the first time in more than a decade. Beginning in December of 2015, the Fed embarked on a 3-year hiking cycle, slowly but steadily increasing its policy rate from 0.25% to 2.5%, with the final hike in December of last year. The Fed’s tightening put the U.S. central bank at odds with their global counterparts, as many maintained easy policy. However, since December, the Fed has made an about-face, having flipped from tightening to now easing.
A Stubborn Curve
On March 22, the yield on 3-month T-Bills moved above the yield on the flagship U.S. 10-year T-Note, but the “inversion” only lasted a few days. However, it went again on May 23, and has since remained. This is notable, because the longer a yield curve inversion persists, the greater the probability of recession. This picture is a stark contrast to the yield curve plot from early November. As we shared previously, equity bear markets that coincide with economic recessions on average experience 15% larger losses (from 28% to 43%).
Coming to Terms with Rising Rate Risk
With the hike in mid-June, the Fed has now raised its key interest rate seven times since embarking on its current tightening cycle in December of 2015. Presently, the yield on 3-month T-Bills is near 2% for the first time in over a decade. Yields on the flagship U.S. 10-year Treasury Note have eclipsed 3%, more than doubling over the last two years. In that time, the yield curve has flattened quite dramatically, especially in the key 2-year to 10-year zone.
Trade War Reignites Dollar Strength
The geopolitics of tit-for-tat tariffs and trade disputes this spring and summer has largely gone in favor of the U.S. dollar, with the index rallying around 7%, bringing it back up to a key technical level around 95. As a result, strong-dollar headwinds have begun to re-emerge, with downward pressure on commodities and foreign investments being the most noticeable thus far.