June, You're Up!

lance_HSFor months we’ve been asking: Are the markets too concernrned about what the Fed says and what it plans to do, or is the Fed too concernrned about the markets? Its officials have walked back and forth on their comments all year, and no one’s really been sure what they’re up to. The markets have been permanently on edge!

Well, from the Fed meeting minutes earlier this week, it looks much more likely that a June hike is now on the table.

The economic data isn’t great, but it has improved. Wages are up a bit. Retails sales came in strong last month. U.S. markets have been flying high for three months now. Maybe, if the Fed can get the markets thinking about a hike ahead of time, they won’t freak out again like they did in January. That’s the idea, anyway.

But I think the Fed recognizes they’ve lost credibility and need to act. In a recent New York Times interview, St. Louis Fed President James Bullard admitted that credibility is a major issue for central bankers right now.

No! Really?

The Fed raised rates in December after talking it up for over a year, said they’d hike four more times in 2016, changed it to two, and has gone almost six months without another move.

That doesn’t inspire confidence. All in all, the bond market’s not buying it, either.

Yields did shoot up on Wednesday after the Fed admitted that a June hike is now more likely. My Treasury Profits Accelerator readers sure liked that since I put them into a correlating trade a few weeks ago. Bondholders realized if the Fed’s going to raise rates, bond prices will take a hit. So, they dumped some of their exposure and yields went up.

But that hasn’t been the trend over the last several months.

Investors have been more defensive as they’ve plowed into 30-Year Treasury bonds, which is about as defensive as you can get without going to cash. Hence, yields have been dropping all year. And if the economy weakens and maybe goes into a recession, they’ll drop more. The difference in short-term rates and long-term rates will narrow as the yield curve flattens.

I’ve discussed this before, but a flattening yield curve is a great sign that the economy’s not improving.

In fact, the yield curve looks worse than it did in December when the Fed last hiked rates.

US Treasury Yield Curve Since Fed Hike

Normally you’d expect to get paid a significant amount more putting your money in a 30-Year Treasury than the shortest-term bonds. But when yields drop this much, that no longer becomes the case.

That’s what we mean when the yield curve flattens. You get paid less for longer bonds relative to shorter ones. And since this is basically a measurement of investor sentiment, a flattening yield curve means the bond market is not forecasting a rosy picture of the economy.

If the bond market believed the economy was improving and more rate hikes were on the way, the blue line in the chart would be above the red line, not below it.

Only the very short-term rates, under six months, are higher today than they were after the rate hike last December. And that may simply be due to the fact the Fed raised the overnrnight rate. By comparison, that makes the 30-Year Treasury bond yield look even worse.

So basically, while the Fed promised multiple rate hikes this year after they hiked in December, the bond market’s just not buying it. It’s become less convinced in the Fed’s argument that the data’s improving.

That’s what the yield curve shows. And that’s why it’s such a great measure of economic health.

Still, the Fed’s made it clear that their preference is for a hike in June. A couple Fed officials also came out Wednesday saying there could be another two on top of that this year.

Perhaps its officials think the market won’t panic if a hike is somewhat priced in. The Fed wants to get back to a more normal interest rate setting, but doesn’t want to create another crisis by doing so.

Personally, I care a lot more about what the bond market says than these Fed officials who can’t seem to make up their minds. They’re flying by the seat of their pants based on any short-term data that supports their message. But by and large, investors are still defensive and the bond market just isn’t buying it. The Fed may hike in June. Beyond that, it’s just speculation.

Lance Gaitan

Editor, Treasury Profits Accelerator

Lance Gaitan

Lance has a unique ability to find big gains in the most boring of market. He manages to turn sleeping giants into a monster gain-makers – some of the most profitable investment opportunities of a lifetime.