Central banks are stuck in wait-and-see mode awaiting further clarity from policies that have been firmly in place from last year. It appears the markets are convinced that the Federal Reserve's next move will be a rate cut and that the People's Bank of China (PBOC) will deliver more stimulus after China is able to finalize a trade deal with the United States. The European Central Bank (ECB) was contemplating further stimulus, but a recent run of better-than-expected data may have the ECB on sidelines for a while.
It is likely that the Fed, PBOC and ECB will all need to be patient and wait until after the summer before contemplating any policy shifts. That prolonged wait could provide for some choppy performance in equities, which could see thin conditions lead to some temporary pullbacks.
U.S. stocks have greatly benefited from accommodative stances from the Fed, especially the January pivot, but it seems that the bulk of earnings have provided mixed results and a mixed outlook that are causing many investors to head for the sidelines. The S&P 500 remains near record highs, while nearly 25% of its components are still in bear market territory. The S&P 500 is having its best start to the year since 1987, and we could see many investors walk away.
The bullish case for stocks should remain in place despite investor reassessment on rate cut expectations following this week's Fed remarks. While the Fed may feel transitory factors are at work with inflation, increased productivity could mean that the economy can strengthen without driving inflation higher.
After the news from the Federal Open Market Committee (FOMC), Treasury yields surged higher as expectations remain firmly anchored that the Fed will be patient and keep rates steady before possibly delivering a rate cut. The spread between the U.S. 10-year and two-year Treasury yields continues to widen as yields surge across the board. The steepening of this part of the curve should eventually be felt in the economy in the later part of the year. It appears that inversion concerns will become a distant worry and that we may not see recession concerns resurface until next year.
The Eurozone economy is showing flashes of improvement, but that will need to be a sustained trend before the ECB abandons the idea of more radical monetary policy stimulus later this year. The ECB is unlikely to have a rate rise until the middle of next year at the earliest. We could see those expectations moved up if we see the ECB settles on a hawk, such as Bundesbank President Jens Weidmann, to replace ECB Chief Mario Draghi when his term ends in October. Regardless, accommodative policy will be in place for the rest of 2019.
The PBOC is unlikely to change its easing bias any time soon, as several key components of the economy remain weak. The central bank is concerned about pumping too much cash into the economy, but we should not expect that to derail further stimulus if we continue to see softness from the world's second largest economy.
The Bottom Line
The S&P 500 Index could be in for a choppy period that could warrant a 3% to 5% pullback. Weaker economic data is what will be needed to cement a rate cut from the Fed. For traders who were around in the mid-'90s, this will draw many comparisons to the time former Fed Chair Alan Greenspan delivered a rate cut after raising rates a few times in 1995.
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