US equities markets went ballistic after the Federal Reserve confirmed Wall Street consensus that it will cut the overnight borrowing rate by 50 basis points if the economy weakens. This did not surprise me. The current Fed Funds target rate is 2.25% – 2.50% and US inflation is just under 2%, so the real policy rate is 0.5% and the June FOMC conclave only confirmed, the US central bank would not hesitate to take out a preemptive insurance policy against potential US recession risk due to an economic slowdown in the EU, China and Japan amid global trade tensions. After all, the FOMC statement was unambiguous when it stated, the US central bank will “act as appropriate to sustain the expansion”. Only sudden acceleration in US economic growth non-farm payroll, retail sales, industrial production, or new speculative record highs on Wall Street will avert the momentum for a 25 basis point rate cut at the July and September FOMC.
A long position in the 10 year US Treasury bond futures contract traded in Chicago has been wildly profitable as the yield on the Uncle Sam 10 year note tanked from 3.25% in October 2018 to a mere 2.05% now. This dramatic fall in US Treasury bond yields has enabled US investment grade corporate bonds to be a winner asset as the record highs on the corporate bond ETF (symbol LQD) attests. In fact, the 10 year US Treasury note even traded below 2% on Thursday in New York for the first time since the 2016 China triggered global financial contagion. Wall Street folklore contends the “the trend is your friend until the trend comes to an end”.
The trend suggests the yield on the bellwether 10 year Treasury note could fall as low as 1.80% unless the US-Iran geopolitical confrontation in the Gulf escalates into war or an oil shock that disrupts tanker traffic on the Straits of Hormuz, the world’s most strategic and volatile energy chokepoint. As long as a new war does not break out in the Middle East, the bull market in US Treasury debt will continue.