Market Commentary - July 2019

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Rates Dropping

It appears the race to zero percent interest rates is back on. Currently, over $12 trillion bonds are trading with negative yields! France, Germany, Japan & Switzerland have either zero or negative yielding 10 year government bonds. That's right, if you hold these until maturity, you are guaranteed to break even or even lose money! This total is only likely to increase after the ECB recently indicated it's unlikely to increase interest rates before mid 2020 and stands ready to add more stimulus. While its helped push asset prices higher, the impact on economic growth has been questionable at best.

In the U.S., expectations have shifted drastically. Nine months ago the Fed was signaling for two to three interest rate hikes in 2019. Now expectations are for two interest rate cuts. In addition, President Trump has been continually applying pressure on the Fed to follow the rest of the globe with cutting interest rates. While lower interest rates reduce the cost of borrowing and can make goods more affordable for individuals and corporations, it also tends to fuels speculation and lead to "bad" investments being made. This can lead to the formation of asset bubbles if interest rates are kept low for too long. If the Fed were to move forward and cut rates, their options are limited on what they can do when the next downturn hits. While a prolonged trade war with China has emerged, the sharp u-turn from the Federal Reserve has left many wondering if a global recession is on the horizon or if they merely caved to political pressure.

In June, we witnessed a slow down in job creation (75,000) and a continued unresolved trade war with China. Despite this, global markets are on pace for their third best monthly performance in over 3 years. How? In short, a majority of this negative data has been shrugged off as the hopes for interest rate cuts and additional monetary stimulus have increased. This is not to say all economic data has been disappointing as retail sales have ticked up. The question is how much additional economic growth would arise from a 0.25% to 0.5% interest rate cut? Would it truly spur economic growth or merely help push stock and bond prices higher? While asset prices have increased tremendously in 2019, central banks continue to pile up record levels of debt and Eurozone GDP is lower today vs. 2015 and U.S. GDP is not much higher and that includes the corporate tax cuts in 2018.

The growing concern is the global system has become too dependent on low interest rates which have had a diminishing impact on spurring economic growth. The U.S. is in a tricky spot as their economic growth is stronger than most but at the same time a majority of developed countries continue to cut or maintain low interest rates. The Fed must either follow suit or risk having the US dollar appreciate which could have a negative impact on growth. One thing is clear, the longer interest rates remain this low, the larger the potential risk down the line. If inflation were to unexpectedly spike, things would get tricky as central banks would be forced to raise rates to combat inflation and global markets would surely be spooked. As worrisome as this can be, trying to decipher when a prolonged downturn will commence and for how long has been proven to be near impossible. In addition, right now both good and bad economic data is being cheered and boosting stock and bonds values. As mentioned in my market commentary last month, avoiding making rash investment decisions based on headlines is always recommended and those who stayed the course were rewarded handsomely in June.