The world central banks were busy this week. The Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan announced their latest views of the health of their respective economies.
The Federal Reserve concluded the scheduled two-day meeting on Wednesday and as expected, decided to keep the Fed Funds rate at an upper bound of 2 percent. Chairman Powell stated the U.S. economy is growing at a strong rate and job gains are healthy. Across the pond, in a controversial move, the Bank of England decided to raise their key rate on Thursday. Some economists believe this policy to be too aggressive given the degree of uncertainty around Brexit. It has been almost a decade since England has seen current rates of .75 percent.
The Bank of Japan (BOJ) and the European Central Bank (ECB) both have their key rates below zero. The BOJ is continuing its current quantitative easing policy to stimulate the Japanese economy. The ECB kept its rate at -.40 percent late last week, but it is expected that they will end their asset purchase program soon, despite low growth of .3 percent in Q2.
Areas of the globe are growing at a different pace, and each central bank is doing their best to stimulate economic expansion while avoiding unintended inflation.
Revisiting the Fed’s rate policy, the short end of the yield curve is being affected the most. As can be seen in the chart below, the 2-year Treasury yield has been moving up in tandem with the Fed Funds target rate (upper bound), while the 10-year Treasury yield has only moved up modestly.
If the Fed continues to raise rates and the 2-year Treasury yield reacts in similar fashion, the risk of a yield curve inversion will increase. A yield curve inversion happens when short rates are higher than long rates, which historically has been a negative sign for the economy. However, we don’t believe investors should be alarmed if we see a yield inversion. In fact, looking at the last five recessions, there has been a lag on average of over 13 months before the S&P 500 has peaked.
The environment is also different this time around. In January of 2006, the last time the curve inverted, the US 10-year Treasury was over 4.3 percent, while today it sits just below 3 percent. The rest of the world has seen a similar shift; the 10-year German Bond was yielding 3.3 percent in 2006 and today that yield is only .46 percent. In Japan, the 10-year government bond had a yield of 1.4 percent in 2006 and today that yield is just .12 percent.
In addition, the latest real GDP growth for Q2 in the United States was 4.1 percent annualized; mostly driven by consumers continuing to spend and positive net exports of goods and services.
Turning our attention to market valuations, the S&P 500 is trading at a forward P/E of 17.5, which is slightly lower than the 5-year average of 17.9. We don’t see any reason for concern now; however, we are always monitoring the markets for news and events that could change our outlook.
In the week ahead, Robert Luna, Surevest CEO & Chief Investment Strategist, will be on CNBC Closing Bell discussing Disney earnings. Tune in on Tuesday, August 7th between 4:00-5:00 p.m. EST to watch our outlook on Disney.
[i] “Fed Leaves Federal Funds Rate in Target Range of 1.75-2%” Bloomberg
[ii] “Carney Keeps BOE Rate Hikes on Agenda in Face of Brexit Risks” Bloomberg
[iii] “Euro-Area React: Slower Growth, but ECB Won’t Extend QE” Bloomberg
[iv] “Stock Investors Should Not Fear the Inverted Yield Curve, Strategist Says” MarketWatch https://www.marketwatch.com/story/stock-investors-should-not-fear-the-inverted-yield-curve-strategist-says-2018-07-17
-Luis Galmadez, Director of Research and Trading, Surevest Private Wealth
-Robert Luna, CEO & Chief Investment Strategist, Surevest Private Wealth