Why No Big Drop On Truly Bad China Economic News? Look To The Bond Market

China and other export-oriented Asian economies delivered really grim news on growth last night and yet U.S. stocks have refused to move into the red. As of 2:20 p.m. New York time on Thursday the Standard & Poor’s 500 index was up 0.07% The NASDAQ Composite was head 0.52% and the Russell 2000 had gained 0.51%. Only the Dow Jones Industrial Average, with its heavy weighting in exporters such as Boeing (BA) and Caterpillar (CAT), was off with a slight decline of 0.18%.

What gives? Why not more of a reaction by U.S. stocks to the bad news on growth in the global economy?

Because the bond market–and investors and traders in general–have decided that the latest dose of bad news GUARANTEES that there will no interest rate increases from the Federal Reserve in all of 2019.

The CME Fed Watch tool, which takes the measure of expectations for future interest rate moves by the Federal Reserve by looking at prices in the Fed Funds futures market, now puts the odds of an interest rate increase by the Fed at its January 30 meeting at 0%. For the March 20 meeting the odds according to the Fed Funds futures are a minuscule 0.5%. For May 20 the odds of an interest rate increase rise all the way to 2%–but we get the first signs of money voting for an interest rate cut at 0.5%.

Want to go further out? At the June 19 meeting the odds of a rat increase are just 9%. At the July 19 meting the odds are just 10.7%. September 18? Just 14.7% see an interest rate increase. October 30 is also at 14.7%. The odds of a Fed increase at the December 11 meeting stand at 20.1% and for the January 29, 2020, the odds of no cut are at 66.9% and the odds of an interest rate cut climb to 23.5%.

Two observations on these odds. First, my rule of thumb is that, since the Fed doesn’t like to surprise markets and looks for 65% or better odds before making a move, the U.S. central bank will have to really gun up the propaganda engine to move the market into something like a receptive mood to even consider an interest rate increase as a possibility anytime in 2019. And second, the markets are starting to price in possibility of a recession in 2020.

What does all this have to do with the market’s move–or lack thereof–today? Lower interest rates support stocks because they lower the attraction of bonds as an alternative to equities and because they argue that the easy (or easier money) will support U.S. economic growth.

And we’ve had what amounts to a massive move in bond yields in the last month. Today, January 2, the yield on the 10-year U.S. Treasury was just 2.66%. That’s a drop of 32 basis points (100 basis points make up 1 percentage point) in the last month. The yield on the 2-year Treasury is down to 2.51%. The yield on the 5-year Treasury sits at the same 2.51% level. The yield on the 2-year Treasury is down 28 basis points in a month and the yield on the 5-year is down 31 basis points.

In the shortest of runs, the financial markets look to have decided that lower interest rates are supportive to stock prices–even if they may be signaling a recession.

In the middle and longer runs, the market’s conclusion worries me. Because the markets could be wrong. Having discounted all interest rate increases for 2019–already–the potential surprises (one interest rate increase in 2019) are all on the downside (if the economy doesn’t look so week that the Fed will abandon all interest rate increases in 2019). And because I don’t think it will take the market long to go from “Gee, lower interest rates support the economy” to “Oh, no, lower interest rates signal a recession.” And because the market is, in my opinion, watching the wrong piece of Fed monetary policy. The Fed’s continued plan to shrink its balance sheet is more important to liquidity (the Fed selling amounts to a move to tighten liquidity in the economy) than changes in the Fed’s benchmark short term interest  rates.

If you thought 2019 was going to avoid the volatility of 2018, the signs so far say you’re going to be disappointed.