June Outlook
June 11, 2020  |  By Hank Cunningham

Fed Chair Jerome Powell delivered a sobering assessment of the current and projected economic landscape. The Fed will leave its Fed Funds Rate unchanged until 2022. While the Fed cannot directly control bond yields, it can exert considerable influence over them. Indeed, market observers believe the Fed may resort to some measure of yield curve control should yields rise more than the Fed would like.

There is a recovery underway, as witnessed by the stunning employment report and the strength in equity markets. Thanks to the Fed’s actions, liquidity has been restored to credit markets. Not only have yield spreads between corporate and government bonds narrowed, but there have been record numbers of new corporate bonds issued.

Government bond yields jumped twenty basis points after the June employment report but they retreated by the same amount after Chair Powell’s gloomy assessment of economic conditions. While not announcing any new measures, the Fed has made it clear that there is “no limit” to the tools it has at its disposal. Once again, the market has learned to “not fight the Fed.”

The consensus view is that, as the full effect of this unprecedented stimulus hits global economies, inflation will rear its head. It is not difficult to see sharp price increases ultimately in important items such as food, restaurants, air fares, hotels and wages. That moment is, however, far into the future as global economies struggle with the forces of deflation for the foreseeable future.

Thus far, the gigantic increase in the U.S. budget deficit has mostly been absorbed by the Fed’s balance sheet, which has ballooned by some $5 trillion dollars with no apparent ceiling. It is on its way to $10 trillion this year. With the Fed monetizing this deficit, one outcome has been a weak U.S. dollar. Our conclusion is that the yield curve will steepen further and that we have seen the lows in long-term government bond yields.

Along with a rebound in energy prices, this weakness in the U.S. dollar has led to a steady rise in the Canadian dollar.

As to bond yields, the Fed has anchored short-term yields close to zero. The yield curve has steepened, in recognition of not only the long-term implications of record issuance of Government bonds but also the ultimate increase in inflation.

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May Outlook
May 12, 2020  |  By Hank Cunningham

The consensus view is that the massive, unprecedented monetary and fiscal stimulus unleashed to date is sufficient to contain the slump to a deep recession, avoiding the experience of the ‘30s. Already, there are pockets of recovery taking place globally, making it likely that we have passed the nadir of the recession. Of course, economists have, as in the past, resorted to labelling the likelihood of recovery as “V”, “W” or “L” shaped. One school of thought forecasts it as a “swoosh” comeback.

In the short run, inflation measures are sliding, raising the specter of deflation. At the same time, the massive fiscal stimulus is producing never-before-seen budgetary deficits; in turn, this means record issuance of government bonds. The U.S., for example, will issue some $910 billion of notes and bonds in the third quarter. The net result is likely to be an ultimate return to an inflation cycle. At present though, actions by central banks everywhere are pinning short-term yields close to zero while longer-term bond yields are moving gently higher.

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April Outlook
April 14, 2020  |  By Hank Cunningham

The global economy has entered a recession and the primary questions are: how deep will it be and how long will it last?

There are no answers to these questions and there won’t be until we see the end of this pandemic. Concerted massive monetary and fiscal stimulus has been introduced throughout the developed world. With monetary stimulus at its maximum, the onus has fallen on the various fiscal stimulus measures. The massive programs announced thus far should help to bridge this period when revenues and incomes have mostly ground to a halt.

Interest rates and bond yields are low and will remain so. The Fed has breathed life into the corporate credit market but there will likely be widespread downgrades as well as a pickup in corporate defaults. There will also be a tsunami of new government bond issues to fund the various stimulus packages. Since we are in a disinflationary world, such issuance will not push bond yields higher in the near future. Ultimately, there will be inflationary consequences but that is a long way off.

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