U.S. equity futures started the week higher in overnight trading, even though the global manufacturing sector is about to contract, and commercial lending has started to contract. Both have led to lower stock prices and recessions in the past. Investors continue to brush off any bad news and bid stocks higher, proving that little has been learned from the prior two recessions.
The gap between stock prices and Treasury yields eclipses that of the prior two recessions, meaning either stock prices are headed down, or Treasury yields higher. In 2016 there was a large gap between stock prices and Treasury yields, but it was retail investors who dumped their bonds to catch up to the stock market. Today, the largest commercial banks in the U.S. and foreign central banks are buying long-term U.S. Treasury bonds.
The recent move in gold has the Internet on fire about how gold is going to make a significantly large move higher in price. The markets are pointing to tensions with Iran and an expected rate cut by the Fed next month. The real story of why investors are calling for a rate cut has nothing to do with either.
Hedge-fund managers and speculators have been massively long Eurodollar futures, which are dollars held in European banks. When European Central Bank President Mario Draghi announced last week that he is prepared to ease, the Euro rose against the dollar, which squeezed anyone long Eurodollar futures.
To hedge their long Eurodollar futures, hedge-fund managers were also long gold. When they were stopped out of their Eurodollar futures, as the Euro unexpectedly rose, the dollar fell which sprang gold higher. If gold were to break out here, then Treasury yields need to fall, but hedge-fund managers are short U.S. Treasury bonds. For the moment, the U.S. Treasury bond market is preventing gold from breaking out.
Investors who are betting on a Fed rate cut, are likely to be disappointed. The Fed used one of the oldest tricks in their playbook – talk. The Fed told investors what they wanted to hear, and investors, in turn, bought more stocks. Given the positive correlation between stock prices and retail sales, the Fed is hoping stronger retail sales will drive the economy forward without having to cut rates.
The Dallas Fed Manufacturing survey crashed to its three-year low as the survey dropped from -5.3 to -12.1, as analysts expected a -1.0 print. Crude oil production is a strong driver of business in Texas, and as the manufacturing survey falls, so too should crude oil prices.
Stocks traded flat on the day as trading volumes collapsed back down to their recent lows. Treasury yields fell slightly on the day and crude oil continued to rally in hopes that a conflict with Iran will draw down the large crude oil inventory. Agricultural commodities rose slightly in anticipation of the USDA’s crop progress report that was due after the closing bell.
The big star of the day is gold, which investors are now piling into in hopes of not missing out on a big rally. The rally in gold is leaving the junior gold miners and the silver miners behind, which is rather unusual. Despite the enthusiasm for gold, the catalysts being pushed by the financial media are not supporting an all-out rally. The rally in gold is a good early indicator to buy the next major pullback.