Listening to the Fed: Making Sense of the Rate Cut
Featuring Tony Greer
Published on: August 1st, 2019 • Duration: 16 minutesTony Greer, editor of the Morning Navigator, breaks down why the FOMC decided to cut interest rates for the first time in a decade. Greer reviews why he is actually on board with the 25 basis-point cut, and discusses how traders should position themselves in the weeks and months to come, in this interview with Jake Merl. Filmed on the afternoon of July 31, 2019.
JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl, sitting down with Tony Greer, editor of The Morning Navigator. Tony, great to have you back on the show.
TONY GREER: Thanks for having me, man.
JAKE MERL: So, we just saw the first rate cut in over a decade. Powell just got done giving a speech. And personally, this is the first rate cut I've seen. I know I'm a student of the markets, just getting into the markets. And I want to get your thoughts. Is this a good thing? A bad thing? What's going on?
TONY GREER: Yeah. I guess we should set it up with some history since you're a student of the market. Last time the Fed cut rates, we were addressing the housing crisis. So, we started off with Fed Funds at five and a quarter and wound up lowering them to zero over the course of I think just over a year. And during that time, the market got shellacked, because the stock market was then falling in the mortgage crisis. We were dealing with- excuse me, we were dealing with Bear Stearns, we were dealing with Lehman Brothers going bankrupt, the whole thing.
We had a much different economic background as well. We had higher oil prices, we had oil prices up at 95. So, we had higher interest rates at around 4% in the 10-Year, so things were much different. We were addressing then what was coming out of a crisis. Right now, we're not coming out of any crisis. It seems like a sort of smartly prudent rate cut to me, believe it or not, and this is a little bit of a change of opinion for me. I originally thought that Powell was one hundred percent beholden to Trump for this rate cut.
He literally seemed optically like he was just caving to the President pointing around the world saying, being a complete baby, the way he knows to be. Everybody else gets lower rates, why do we have such high interest rates? President Obama got zero interest rates for his whole 10-Year. Why do I have to have 3% interest rates? So, he conflates the stories out of nothing, and starts putting pressure on the Fed Chairman.
And that's when we saw even more of a dovish pivot but we saw the dovish pivot go around the world. And it was really in reaction to a collapse in the manufacturing sector, which was really evident, like you can see them go right around the world, Europe to China. We saw PMIs tick down from either the mid-50s to high 50s to the low 50s and then some into the high 40s. Now, as you know that PMIs, we judge economic expansion and contraction as being either north or south of 50. So, we've seen Europe already go into economic contraction due to the trade wars.
At this point, we've seen the market falter, when we have fears of trade wars tipping equity earnings over and having a negative effect on the economy. So, what do we have every time we see that? US gov to the rescue. Like we saw Steve Mnuchin back in December, the government comes to the rescue, says there's going to be plenty of liquidity at all the banks and the market manages to recover. So, the market gets back on its own feet. And we go into earnings season and earnings start coming out positively and then the S&P can continue to run from there.
So, while it seems completely absurd that we are cutting rates with the stock market at an all-time high, and with unemployment at 3.7%, and with PMI even at 51.7 indicating expansion, and no sign of inflation, it does seem like preemptively a smart idea considering the ECB just turned full dove after in response to their PMIs coming off. If there's no pivot by the Fed, then we wind up with a widening interest rate differential with US over a several other countries and probably a strengthening dollar. And then really, a super strong dollar is going to hurt our exporters- something that the President doesn't want. To me, we can't be the outstanding hawk on the planet right now, because it would just topple too much within the system, which seems to be going along just fine right now.
One of the things that's interesting that Powell said was that they're not going to change- they're not going to cut the balance sheet down anymore from here. To me, that's directly addressing the fact that's for Trump. That's to say that, okay, look, we're going to leave the balance sheet right where it is so that it doesn't mess with the stock market. The 25 basis point cut seems like it's rational in response to PMIs around the world coming down, and US PMI coming back.
So, if we fall below 50 and start seeing a drag on economic data, they will look smart and have said, okay, we're a little bit ahead of this. And as you would have expected, he left the door open for another rate cut. And the reason that he has to do that, in my opinion, there's no way that the Fed can almost never any more signal that they're done for good cutting rates. Because then, their risk is they say that they're done cutting rates, the economics of the US stay sideways to firm, and the stock market backs off.
Now, what do you think they're going to have to do if the stock market backs off? They're going to have to cut rates or they're going to have to go there and do something. So to me, it makes sense for them to say, yeah, we will address as time goes by, we'll make it data dependent. But they definitely didn't rule out another rate cut. So, it seems to me now as the markets go, it seems like the equity market is probably going to go by business as usual.
There's a little bit of a dip today in response to- it's probably sell the fact type of response where we were expecting a quarter of a point, we got a quarter of a point, nobody knows really what's going to happen next. So, let's probably take profits on the stocks that we bought in the last three to six weeks, at least. So, that move doesn't scare me and nor does it- I'm not going to be one of those guys that's out there saying, okay, here comes the big tumble. Rather, I would be looking to posture myself to buy a dip in this environment. We get an S&P pulled back to its moving averages, I would certainly take a chance and look for the stocks that I want to get long and buy them.
JAKE MERL: Would that be the 50-Day Moving Average, 200-Day?
TONY GREER: Yes, somewhere in there, depending on how fast it gets there. Rate of change is everything. So, if we fall down there in the next two sessions, I might be a little hesitant. If it takes us two weeks to back and fill into that area, then I think it's a good idea to do some shopping and get a little bit longer the stocks that you want to buy or put new length on in stocks that you've been looking at and have had on your radar. So, I think that's the way that I'm going to play it.
I've still got a fairly outsized bond short position on for me, and I'm trafficking right now on IEF, that's the 7 to 10-Year Treasury ETF. My premise for the bond short was that interest rates had fallen too far given the strength of the economy. All of a sudden, it seemed to me like the Fed was on hold. And then they said, okay, we're going to respond to changes in the market. And we saw some economic weakness abroad, and bonds just went on a run. And absolutely knocked interest rates much lower across the curve. But we're still sort of being sensitive. And I think that the Fed is also being sensitive to that curve. Because the big alarm that everybody watches is the 3-Month 10-Year spread.
3-Month 10-Year spread touched down at zero in March of this year. When that spread touches zero or goes inverted, a recession has followed more often than not. So, I think the Fed is saying, we're seeing numbers come off abroad, we've got this 3-Month 10-Year spread as a little bit of an alarm going off in the office saying there's usually recession that follows this. And so, maybe they're being prudent and following along with that narrative in their rate cut.
So, the bond market to me, this is going to be another test. Since I'm in the 10-Year part of the curve, I'm going to talk about that. But to me, this is going to be the ultimate test of 2% in the 10-Year, I've been calling it The Battle of 2%. Rates came from a high of about three and a quarter or so, came tanking down to 2% in the 10-Year, and so far, we've been sideways. So, I'm looking for more and more data in the US to hold steady or maybe even improve and to catch the bond market which has gotten overly, overly optimistic and bullish offsides to a point where the bond market has to sell off, and 10-Year Yields have to trade up higher.
So, this isn't a generational trade. This is just a feeling that the bond market is overbought, sentiment is overly bullish, everybody is positioned long. And so, let's take a chance at fading that and seeing if the US economy stays sideways and we have a chance at rates retracing to where they came from. So, that's basically the way I'm playing it, it feels like stocks can probably hold a dip and go on rallying business as usual. The Fang complex is still driving the markets and performing fairly well.
JAKE MERL: So, would that be a short-term trade? Or are you bullish on the markets in general for more of a longer term picture as well?
TONY GREER: Yeah. My timeframes, Jake, are usually somewhere from- trading timeframes are a week to two months and investment timeframes are three months to a year or maybe a little bit beyond kind of thing, if you get lucky and something really continues to perform. But for a bond trade, this is something that's very tactical. Where I am, yields fell to 2%, I put the trade on at this level, and when they break, if bonds rally and break through 2%, that's where I get out. So, I'm not risking a large amount of money at all, I just waited for them to get to this level, I sold Treasuries via the ETF. And I'm going to see what happens now.
But most importantly, like I said, I think that the equity market can probably sustain this. I feel like no matter what, if there is another steep pullback in equities that we're going to hear from Steve Mnuchin again, they're not going to change the game plan at the White House or at the Treasury. The goal is the stock market to continue up into the right. And it seems like President Trump continues to get his way.
So, that's my wrap up. As long as I originally thought it was a really Trump-induced rate cut. And now, I feel like it might be just the prudent thing to do for markets. And the thing about the balance sheet, to me, that's saying that they don't want to do anything that's going to cause anything to raise rates in any way, which the balance sheet tapering could do. And I think that's another throw in for Trump so that he can know that they're not going to tamper with the balance sheet. And so, that's where we are now, I think it might be business as usual for stocks. And I'm going to keep fighting this bond short for as long as I can.
JAKE MERL: So, we just saw Powell speak. And actually, the Dow fell about 400 points during his press conference as he was talking about this may be a one and done type of rate cut and during a mid-cycle. But let's say the data does stabilize, and we don't get more rate cuts, is it back to bad as good, good as bad? How do you see it playing out?
TONY GREER: Then it goes back to listening to what Trump wants quite honestly, if you ask me. I think that that bounce off of the lows when there was some iteration of Powell saying that we may have been a one and done rate cut situation, I think that may have been coincidental type of thing. I'm really all about where the market closes on the day. And I think that once all is said and done today, it will look just like a sell the fact sell off in stocks where it's nothing fatal. But it proves to be a reason for stocks to pull back off the all-time highs.
It's not like we're having a pullback from mid-range. It's not like we're plunging to lower levels, we are simply having a pullback from the all-time high. So, in as much as the President wants to keep that going, say that the situation stabilizes, the economy stabilizes and there's no rate move in either direction. If central banks around the world continue on their dovish path and lowering interest rates, you will hear from the President pressuring the Fed.
And we've also got to see what happens with trade wars. Because the tariff war does not look like it's going to end anytime soon. We just spent about a half of a year in a positive feedback loop in the stock market where the stock market rallied every time there was a sniff of talks about trade tariffs and coming to any kind of a negotiation situation. That turned out to be completely false. Like there is no imminent solution to the rate talks.
So, in as much as this is something that continues on, it continues to put pressure on European and perhaps the Chinese economy. They continue to lower rates in response, it would not be outrageous to watch the Federal Reserve have to pivot back dovish again and say, you know what, we don't want to be the outlier here. Because that's what it's become. That's what it's become, there's no longer a, the US economy is fine, we don't need to change rates.
In the FOMC statement, Powell actually mentioned things like the Brexit and the debt ceiling as reasons for concern. And that's when I want to grab the TV screen and go, are you kidding me? That kind of thing is outrageous to me. So, we're managing our own economy with our own interest rates and our own currency within our own borders. So, it seemed like we should be most attentive to what's going on here. That's not the case anymore.
So, that's why you've got to watch and see what's going on around the world. Because it seems like the powers that be are the central banks have done a pretty masterful job at managing coordinated currency destruction. We're all lowering rates around the world at the same time, and it's everybody in the boat. So, the dollar has been the stock absorber that's right in the middle and doesn't really rally. Meanwhile, there's an existential battle going on FinTwit every day about whether the dollar remains the reserve currency or not. So, to me, the central banks are making it pretty clear that it's going to stay exactly where it is, especially if you have countries like Japan pinning rates to zero, et cetera, et cetera. So, that's my view from here, Jake.
JAKE MERL: And so, there is weak global growth. We've seen it in Europe, we've seen it across the globe. Are you worried about a recession here in United States?
TONY GREER: Yeah, only because I don't want to blow off the bond market. That's my thing. I don't know. I will never know. I am not capable of predicting. All I can do is read the signals and look at history and decide if I want to trade on them rhyming or not. So, really, I don't look out my window and feel a recession, or I don't see one, it's still tough to get a steak reservation in New York City on a Tuesday night. So, maybe this isn't a good place to look for a recession, et cetera.
But I don't really see us slipping into one, the way corporate earnings have been, it feels like the economy is hanging in there, it feels like the technology side of the economy is really booming. And now, the transport side of the economy is starting to boom again, while other sides of the economy are slowing down. So, long as the consumer remains strong, which we've been and we've got exceedingly high consumer confidence across the board. I don't see it yet. I don't see it yet.
I'm not going to say that it's not going to happen and my eyes are wide open and I'm ready to trade it but I don't see evidence of it yet. I really don't. So, we have to watch the spread and see if the bond market stays where it is with the 3-Month 10-Year spread either flat or inverted and to see if that's proven the same as the last few times whereas after 2000 and 2007, where nominal GDP took a tumble right after that. But it doesn't seem like we're set up for the same situation because we don't have two crises to pull us out of anymore. So, unless there's one that I'm not catching yet.
JAKE MERL: All right, Tony, thanks for breaking it down for us. We'll see how it plays out in the months to come. Thanks so much for joining us.
TONY GREER: You're welcome Jake. That was great.