Fed Enacts Emergency Rate Cut. New Record Lows on Treasuries

This morning at about 9 AM central, in response to the Coronavirus, the Federal Reserve announced an emergency 0.50% rate cut.

The initial response by the market was to send stocks and gold soaring. As the day wore on U.S. stocks crumbled losing about 3.5% at one point and ending the day down 2.8% while gold hung on for a 3%+ gain.

The 10-year Treasury yield continued to slide throughout the day (sending bond prices up) and even got below 1% for the first time ever! Think about that…in the almost-250 years of this great Republic we’ve just set a record low on bond yields.

I’ve been talking about rates in the U.S. approaching zero for several years now. Remember that in 2018 the 10-year Treasury rate was about 3 1/4% and almost every advisor I spoke with and “expert” I heard on the financial news viewed it as a foregone conclusion that rates would rise, and the Fed would continue tightening monetary policy. Look at us now.

At the time I believed strongly that, ultimately, when the next bear market in stocks came, Treasuries would end up close to zero as a result of: (1) a flight to “safety” from investors fleeing risk and (2) the Federal Reserve pushing interest rates down and printing money to buy Treasuries.

This is why I’ve owned intermediate-term Treasuries within clients’ fixed income sleeves for several years.

Remember, bond rates and prices move inversely. Falling rates = rising bond prices and rising rates = falling bond prices. So when rates are falling the bonds are appreciating.

Additionally, Treasuries have historically been a nice hedge against stocks in times of market stress.

The selling of stocks and mass buying of Treasuries and gold today is not a good sign. It’s a sign of panic and fear…a flight from risk towards safety…a rush for the exits in a burning movie theater.

Combine this with the massive moves experienced in stocks over the last week or so, and we notice a dynamic that has only ever materialized during/around bear markets.

This bull market has been going on for over a decade now. That means there are a lot of “young” investors and traders that have never experienced a bear market in their professional life. I wonder how they’ll handle it? Days with historic drops shortly followed by historic face-melting rallies… it’ll be interesting.

In the last year we’ve seen the Fed expand their balance sheet (i.e. print money) and lower interest rates. Meanwhile, gold is up over ~50% from its 2015 lows (23% in the last year). Global stocks are down about 10% from their peak bringing their one-year return to just 5% (including dividends). The 7-10 Year Treasury Bond ETF (EF) is up almost 17% for the last year and up 4.6% just from the 2/19/2020 market peak alone.

All of these things could reverse very quickly, of course. There is not much margin of safety in the 10-year Treasuries any longer. With 10-year rates at 1% the potential upside is about 10% if rates were to go to zero (more upside if rates go negative as they’ve done in other countries). Gold is extremely volatile, and we could get past the Virus with no major issue and see the stock market take off like a rocket again.

Additionally, the market might even take solace if Joe Biden takes the nomination from Bernie Sanders tonight. Who knows. However, these are all short-term considerations that distract from the big picture.

Longer-term/big picture -> stocks are still very far from cheap with valuations near their historical extremes. Furthermore, it’s a very bad sign that stocks couldn’t hold on to gains today with an emergency 50 bps rate cut from the Federal Reserve. It seems all the cut did was send a wave of fear through the markets and wasted one of the Fed’s “bullets.”