Monthly Archives: March 2019

Last Week Today. The U.S. announced it would maintain tariffs on Chinese imports for the “foreseeable” future to enforce the terms of a trade deal, but later appeared to backtrack (or clarify) that not all tariffs would remain in place after a deal is struck. Lighthizer and Mnuchin head to China this week to continue negotiations and additional meetings are planned for next week in D.C. | Following Wednesday’s FOMC meeting the Fed left rates the same and changed their forecast from two rate hikes to no rate hikes in 2019 (which, as discussed below, may be too little too late to avoid a recession). | FedEx cut 2019 earnings forecasts, citing slower global economic growth, which comports with fundamental economic data that has u-turned from synchronized growth to synchronized slowing. | The European Union fined Google €1.5 billion for “anti-competitive behavior.” The fine illustrates the U.S. is not the only country trying to protect local companies from foreign competition and, also, that U.S. corporations are not immune from being on the receiving end of the broader nationalist movement.

After building gains early in the week, global markets gave it all back and then some on Friday with most developed market indices ending the week with modest losses as global growth concerns returned to center stage. First, the Federal Reserve downgraded growth forecasts for 2019, which was followed by U.S. and German manufacturing data releases, that while expansionary, missed consensus expectations for the second consecutive month. In light of slower expected growth, and an increasing likelihood that neither the Fed nor the European Central Bank (ECB) will move forward with plans to tighten monetary policy, sovereign debt yields fell. The yield on the U.S. 30-year “long” bond declined to 2.88% (a fourteen-month low), while the yield on the 10-year German bund went negative (first time since 2016) as the gravitational pull of the Financial Crisis wreckage and subsequent missteps by the ECB prove challenging to escape.

For detailed weekly, month-to-date and year-to-date asset class performance, please click here.

Fed Meeting Summary. The FOMC held their second meeting of the year last week. Investors and economists expected a dovish outcome, which the Fed delivered. Below are the highlights:

  • Fed members’ latest interest rate forecasts (i.e., the “dot plot”) shifted from a tightening bias in December 2018 (blue line) to slightly lower interest rates in 2019 (yellow line) as highlighted in the chart below.
  • GDP projections declined to 2.1% in 2019 and 1.9% in 2020.
  • The Fed will begin reducing Quantitative Tightening (QT) in May and end QT in September. As such, the Fed will start large-scale reinvesting of maturing Treasury bonds on its balance sheet this Fall. The reversal of QT will see a dramatic increase in Fed Treasury purchases. According to FTN Financial, under the previous plan the Fed would have purchased $18.1 billion from September through December of this year, but now will buy between $110 – $120 billion.
  • The Fed continues to struggle with allowing inflation to rise above 2% consistently. Per Chair Powell “I don’t feel we have convincingly achieved our 2% mandate in a symmetrical way….It’s one of the major challenges of our time to have downward pressure on inflation.” While I appreciate his frustration, the Fed missed an opportunity for higher inflation by raising rates too quickly in 2018 when growth was accelerating.


Too Tight. Another, and an arguably very critical, section of the yield curve inverted on Friday when the yield on 10-year bonds (2.439%) fell below that of three-month Treasuries (2.442%). The actual inversion followed Friday’s weak manufacturing data in Germany and the U.S. causing longer-term bond prices to rally (and yields to fall). Yield curve inversions are worth paying attention to, particularly between intermediate and short-term bond maturities, because they have a real economic impact. Since banks generate profits by borrowing-short-term money and lending for more extended periods, inversions can curtail credit creation. When the cost of capital is higher than the return on capital, it simply doesn’t make economic sense to loan money to people and businesses, setting up a positive feedback loop in which credit creation (the lifeblood of a growing economy) is choked off. The inversion doesn’t signal a recession is imminent as previous recessions were preceded by this portion of the yield curve being inverted for at least 10 days, but there is no doubt the Fed took note as it is another indication that the market believes monetary policy is too tight – i.e., the Federal Funds interest rate is too high.


Sources: Bloomberg Financial, L.P. and Covenant Investment Research

If the yield curve doesn’t revert to a positive slope shortly, the Fed will need to make a decision. Do they cut interest rates by 25 – 50 bps quickly to remove the 1 – 2 rate hikes the market believes were excessive from last year, or do they tempt fate and hope the market comes around to the Fed’s perspective that the current level of interest rates is appropriate? If it’s the latter, and the Fed is wrong, history indicates a recession is likely in the next 140 to 487 days (Bianco Research). The indicator is not specific enough for timing the market, but it is an excellent reminder to be vigilant in your asset allocation and ensure your portfolio is positioned appropriately relative to your risk tolerance for higher volatility ahead.

Be well,


Last Week Today. Fed Chair Jerome Powell’s interview on 60 Minutes revealed little new information and was likely intended to clarify the Fed’s current views. Powell did take the opportunity to emphasize confidence in the US economy (while acknowledging it will grow at a much slower rate in 2019) and stress the independence of the Fed “We will never, ever take political considerations into effect.” Powell will have another opportunity to elaborate on the Fed’s monetary policy this Wednesday, following the FOMC meeting. | On the trade front, it looks like a deal with China won’t happen before April. In the meantime, President Trump countered insiders’ claims about Trump’s supposed desperation to complete a deal stating “[he’s’] not in a rush to do China trade deal.” On the other hand, Chinese media cited “substantive progress” in trade talks. | Following weak economic data last week, the Atlanta Fed’s Q1 GDP forecast fell to 0.4%, and the NY Fed’s forecast dropped to 1.37%. | For those of you that may have been out on Spring Break or otherwise missed it, last week we published our semi-annual Economic Review and Outlook.

After taking a shot in the chin the prior week (suffering its worst weekly performance in 2019), the S&P 500 shook off the blow and rallied 2.9% to end the week at its highest level since October 9th. Growth names led the rally, specifically in technology, and the Nasdaq Index surged 3.8%. Global equities chased US stocks higher, though generally underperformed their domestic counterparts. Fixed income investments joined the party as well, as yields across the US Treasury curve declined, and high yields spreads tightened further. The commodity complex presented a mixed bag as gold (+0.3%), copper (+0.3%), and crude (+4.4%) posted gains, while silver (-0.3%) and natural gas (-2.4%) declined modestly.

For detailed weekly, month-to-date and year-to-date asset class performance, please click here.

Black Gold. The International Energy Agency (IEA) issued its latest report on Friday forecasting the “second wave of the U.S. shale revolution” will result in the United States accounting for 70% of the rise in global oil production and nearly 75% of the expansion in liquefied natural gas (LNG) trade in the next five years. The report also predicts that U.S. exports of crude oil and petroleum products will nearly double to approx. Nine million barrels per day by 2024. If the forecast comes to fruition, the U.S. will not only export more oil than Russia but could potentially surpass the current global export leader Saudi Arabia. On the demand side, the IEA’s current forecast acknowledges that electric cars and increased fuel efficiency will modestly reduce demand for gasoline. However, rising consumption for petrochemicals (e.g., plastics) and jet fuel demand will offset automobile-based demand erosion. All in, the IEA is forecasting global demand will increase by an average of 1.2 million barrels per day over the next five years, which is in line with the recent trend).


False Idol. Members of Congress and mainstream press are increasingly mentioning Modern Monetary Theory (MMT), but what is it and why is it drawing so much attention? MMT is a macroeconomic theory that was developed in the early 1990s, but with roots in older macroeconomic theories (i.e., Chartalism and Functional finance) dating to the early 1900s. Like most economic theories, it would take an entire white paper or book to explain the theory in sufficient detail, however, according to the Warren Mosler, the man credited with creating MMT-creator Warren Mosler:

The main takeaways are simply that with the $US and our current monetary arrangements, federal taxes function to regulate demand, and federal borrowing functions to support interest rates, with neither functioning to raise revenue per se. In other words, operationally, federal spending is not revenue constrained.

The implication is that any government that issues currency can always pay its bills (by issuing more currency) thus budget deficits are of less concern. While this is factually accurate, it is also only one aspect of MMT. Politicians touting MMT as a panacea are ignoring the entirety of the theory and the genuine long-term economic and social implications of excessively high debt levels.

Instead, some politicians are interpreting MMT as “free money” to advocate for constituent pleasing, but costly spending policies like a universal jobs guarantee and single-payer health care. While promises of “free stuff” will always garner votes, the reality is that the US is already facing an enormous debt load that will have to be addressed. Removing spending constraints from the government would only compound the debt problem, making any resolution (or reckoning) more painful.

If you’d like a sobering dose of reality, spend some time on To those that argue, the U.S. debt level has been increasing and nothing terrible has happened in the economy, (paraphrasing DoubleLine’s Jeff Gundlach) that argument is about as sound as someone who has jumped off a 100-story building remarking as he fell past the 50th floor “so far so good.”

Be well,


Following a month-long delay due to the government shutdown, officials confirmed what economists and investors already suspected – the economy is slowing. We expect growth to continue to slow towards the 2.0% – 2.5% pace characterized by the post-Financial Crisis expansion, though we caution the potential for Q1 2019 growth to surprise to the downside. However, as we detail in the letter, the domestic economy is on reasonably sound footing, and the economic expansion has room to run if the Fed sticks to their new narrative of being patient.

View/Download PDF

Risk On.  Following one of the worst December’s in the last 30 years, in 2019 equity markets began with one of the strongest January rallies in decades. Though momentum waned in February for developed market equities, risk assets continued higher, and the S&P 500 is now off to the best two-month start to a year since 1991 (in case you’re curious, the S&P 500 finished 1991 with a 30% gain, though that is not a prediction for 2019).

International equities are lagging their domestic counterparts, but double-digit returns only two months into the year are impressive nonetheless. Emerging market equities, in particular, were boosted in February by positive news on a U.S./China trade deal and evidence that the Chinese government untapped the credit spigot to stimulate slowing growth in the world’s second-largest economy.

Incidentally, commodities have also been well bid in 2019. Crude oil has been a significant beneficiary of not only the promise of the U.S./China trade deal, but also from OPEC’s commitment to reduce production. The price of WTI Crude is up 26% to just over $57 per barrel.


Sources: Bloomberg Finance L.P. and Covenant Investment Research

Interest rates remain low by historical standards, but high compared to the rest of the major developed economies – e.g., the yields on the 10-year German Bund and Japanese JGB’s are 0.17% and -0.01%, respectively. Importantly, of late there has been a modest steepening in the US Treasury curve. In addition to the entire yield curve shifting 0.03% to 0.08% higher, the 5-year bond yield is now approximately equivalent to that of the 2-year bond, nearly eliminating the inversion that received much attention in Q4 2018. Treasury curve inversions are a traditional signal of slowing growth and/or recession, and the slight steepening is consistent with our view that a recession is not imminent.

The Q4 GDP estimate was released last week and the 2.6% annualized (inflation-adjusted) growth rate was better than anticipated, as consumption and business investment levels exceeded expectations. Following the growth scare and Fed’s hawkish messaging in late 2018, the Q4 report showed that the economic expansion is not over. However, growth peaked in Q2/Q3 of last year and the Fed’s decision in January of this year to pause rate hikes was the correct one for now. We address both topics in Covenant’s Q1 edition of the Economic Review & Outlook scheduled for distribution within the next two weeks.

In the meantime, be well.