See bottom of email for analyst certification and important disclosures.
Latest Fed cut has fixed the yield curve
The Fed cut rates 25bp and has indicated it will now pause. In our view, this
is appropriate strategy and despite the “pause” has created a runway for risk
assets to continue to rally into YE:
Foremost, the yield curve is now normalized with no points of inversion (see below). In August, we argued the Fed was significantly behind the curve as there was severe inversion between FF and the 5-year. And even in September, we noted 25bp was need to fix this term structure. But now, all points are largely normalized.
This matters because it creates the proper incentives for term premia. Borrowing longer term has progressively higher rates. A normalized term structure is bullish for risk on assets.
Second, the Fed has done a much better job in 2019 of understanding the market’s risks. Last year the Fed committed one of the largest policy errors in history raising in December. This is empirical. If we measure the 5D market reaction to a FOMC action, Dec 2018 was WORST EVER.
BOTTOM LINE: Risk on into YE. As we said in our YE playbook, investors need to be cyclical. US ISM comes out Friday and we expect it to show signs the industrial cycle is bottoming. Additionally, FANG has caught a bid. It makes sense. It’s an ‘odd’ year — FANG historically outperforms in years ending in an ‘odd’ digit.