Here's why stocks are dropping and rates are moving lower

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Published Date 10/26/2018

At 7:00 am ET the 10 yr broke below 3.10% and traded at 3.08%. US stock indexes were under pressure early, with the DJIA dropping -320 and the NASDAQ down -100. After 4:00 pm yesterday earnings from the tech sector were weaker than expected. Amazon, Alphabet, and Snap struck sour earnings notes just after the NASDAQ closed 3.4% higher. The forward guidance also wasn’t what investors were expecting.

At 8:30 am the Q3 advance GDP was better than expected, up +3.5% with estimates at 3.3%; Q2 GDP was at 4.2%. The price deflator at 1.7%% was down from 3.0% in Q2. Real consumer spending expected at 3.3% increased to 4.0%. The price deflator is another report that refutes the Fed’s and markets’ fears about inflation. Consumer spending, which accounts for about 70% of the economy, is the best since 2014, while the 0.8% gain in nonresidential business investment was the weakest in almost two years. Inventories provided the biggest contribution since early 2015, while the drag from trade was the largest in 33 years. Government spending rose by the most since 2016. GDP rose 3.0% from a year earlier, the most on that basis since 2015. The better read took some of the weakness out of the stock index futures. By 8:45 am the DJIA was still down -250. And the 10-yr note rate of 3.08% moved back to 3.10%, the key resistance level as we have been noting.

Earnings for Q3 are still not matching the overwhelming forecasts before last week. Stock indexes in extreme volatile moves imply investors and money managers have been shocked with earnings so far. Meanwhile, US interest rates continue to be moderate in terms of price swings. We made an issue two weeks ago about the IMF lowering global growth in its most recent report. Now investors and big money are taking it more seriously. On the release of the report, there was very little reaction and not much press coverage. It was the first time in two years the IMF cut its growth outlook.

At 9:30 am the DJIA opened down -302 after a small rebound when the Q3 GDP report hit at 8:30 am. NASDAQ opened down -203 and the S&P dropped -47. The 10 yr at 9:30 am was at 3.09%, -4 bps from yesterday.

At 10:00 am the final University of Michigan consumer sentiment index for October said forecasts were for 99, unchanged frm two weeks ago; the index is at 98.6.

Last night we heard from two Fed officials; Cleveland’s Mester and the Fed vice chair Richard Clarida. “While a deeper and more persistent drop in equity markets could dash confidence and lead to a significant pullback in risk-taking and spending,” said Mester, “we are far from this scenario,”…. Clarida added, “While the market volatility poses a risk to the forecast and bears monitoring, it has not led me to change my modal medium-run outlook.” Clarida also downplayed the potential impact of recent stock market turbulence on Fed policy, noting that the fundamentals of the economy are “very, very solid.” The Fed is going to increase the Federal Fund rate by 0.25% at its December meeting, almost a given. Next year the Fed has been talking about two or three more increases, but we can’t take those for granted if the economic outlook dampens and inflation continues to defy the Fed’s outlook.

It looks like another volatile session today in equity markets. The bellwether 10-yr is trading under 3.10%. A close below 3.10% will forecast 3.00% on our technical models. Any improvement in interest rates is directly dependent on the volatile US and global equity markets and the movement in the dollar. Dollar strength now works against the bond market, making it less profitable for weakening currencies to hold US debt. The Fed has to be concerned about the magnitude of the drop in the value of stocks; most were over-valued prior to the last two weeks. It now begs the question: how low before investors see value?

Source: TBWS

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