Yesterday, the markets experienced a much-anticipated move to the upside as technical indicators of all kinds signaled an oversold market that was begging for a catalyst. The catalyst came with a vengeance: the BOE reversing course and buying an unlimited amount of long dated bonds (gilts), to stabilize their currency and financial markets. Although you will hear media pundits bash the BOE, try to make comparisons to other central banks. The move was the best one to make when a rapidly shifting fiscal policy is bound to fail no matter which side of the isle you’re on.
The U.K. recently implemented a fiscal policy that focused on deep tax cuts and expanding other corporate benefits to expand their economy – the type of expansion that brings with it higher wages, higher energy demands, and a lower tax base, which does not address any of the issues they currently face. In fact, every trader, investor, and institution saw the flaws in this fiscal strategy and immediately sold positions, causing the sharp downturn in the British pound and rapid increases in fixed-income yield to the point where their own pension funds were in margin calls. Talk about a disaster.
The U.S. market is not the same as the E.U., U.K., or any other major country out there. Policy will not shift unless a catastrophic credit crunch appears domestically, which would be the “Black Swan” event. Financial institutions have shielded themselves from the catastrophic shortcomings of the 2008 financial crisis. That is not to say a credit crunch is impossible: the iShares Investment Grade Corporate Bond ETF (LQD) is at pre-financial crisis levels, a topic that has taken the street by storm. But this is not a great measure of liquidity, just a measure of corporate bond yields compared to treasuries. Both are seeing levels we have not seen for over 20 years. The CDS (Credit Default Swap) market is seeing a widening of spreads, alluding to some financial “stress,” but even then, the exposure may be limited to over-leveraged investment banks and dicey international real estate markets.
The focus should still be on the domestic fundamental data. Personal Consumption Expenditures (PCE) Index is released this Friday, a key metric for the Fed. ISM Manufacturing PMI, another key barometer on the state of the economy, will be released next week along with JOLTs (Job Opening and Labor Turnover Survey). These indicators need to reflect a slowdown in the economy. That will be the catalyst. Everything else is just noise at this point. So, “Don’t go chasing waterfalls”, because convincing yourself to believe in a narrative that is not 100% baked typically leads to losses.
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