Powell took a measured approach in his first speech as Fed chair as he gave reasons why the Fed shouldn’t hike too quickly and why the Fed shouldn’t hike too slowly. This is a slow hike cycle overall, but he means even slower when describing a speed which is too slow. Too slow could be construed as one hike per year.

He expects inflation to increase to the Fed’s 2% target. He noted how the economy was strong and how the labor market was strengthening, but not at full employment because wage growth hasn’t been heating up. He made the point I’ve been making which is that the slack in the labor market is being supported by workers coming back into the labor force. The latest futures pricing shows a higher chance of two hikes than four hikes. I remain in the camp that expects two or three hikes because the economy is weakening. I think the main reason expectations have become more dovish is because of the correction in stocks.

Stocks Fall

There was yet another wild day on Wall Street as stocks sold off because of the $100 billion in proposed tariffs by Trump on China. The S&P 500 was down 2.19% and the VIX was up 13.46% to 21.49. It’s tough to understand what Wall Street thinks of these tariffs because it ignored the Chinese tariffs on Wednesday, but followed through with the decline on Friday. Part of the reason for the decline might be that the market was up 3.14% in the prior three days. We are in a new era of increased oscillations in the market as it decides if it wants to stay in the range it has been in for two months or if it wants to try for a bear market. Earnings season can’t come soon enough because they might help stocks improve.

Bonds Rally

The 10 year yield had a steep decline as it fell almost 6 basis points to 2.77%. The 2 year yield fell about 4 basis points which means the curve steepened. The latest difference between the two is 51 basis points as the curve has been steady in the past few days. The forward curve for the 1 month overnight index swap has slightly inverted after the 2 year forward point. This implies rate cuts after Q1 2020. This supports my long term forecast that there will be a recession in either 2020 or 2021.

Sentiment Swing

I would be amazed at how quickly sentiment swings occur in the market if I hadn’t witnessed it occur so many times. The CNN Fear and Greed index is at 9 out of 100. It has been in the extreme fear category for over a month. There are now reports in the Wall Street Journal of people saying volatility going up is guaranteed as it is the new safe haven. I remember a few months ago when headlines stated that stocks could never fall again. In the past few months, the two big changes are the weakening economy and the potential for a trade war.  The chart below shows the net long and short bets on the VIX. As you can see, the leveraged funds and asset managers are long volatility for the first time since early 2016. The economy is in much better shape than in early 2016, but the Fed is now more hawkish and there are threats of a trade war. Either way, this is still an indicator you want to fade as stocks should regain their footing in the next few months.

Double Whammy From The ECRI

The ECRI leading index is about to signal a double whammy in that growth is expected to slow in the near term and in the intermediate term if the latest trend keeps up. The growth peaked in February and has been falling since then. The 4.5% growth isn’t anything to worry about, but the trend makes it look like it will hit negative growth in the next few months. Right now, it looks like Q1 and Q2 will be weak and Q3 will see a rebound which might be temporary.

As I mentioned before, the GDP Nowcast from the Atlanta Fed has GDP coming in at 2.3% in Q1. The latest estimate from the NY Fed is for 2.77% growth which is up from 2.71% last week. There was a lot of data discounted, but not much change this week. The Atlanta and NY Fed are relatively close to each other. I’m going with the Atlanta Fed and the blue chip forecasts. I rarely side with the blue chip average. The NY Fed’s  Q2 forecast is for 2.91%. I expect Q2 growth to be faster than Q1. The St. Louis Fed’s estimate for Q1 GDP growth was lowered to 3.42%. It’s still the most bullish of the bunch and will likely be the most wrong unless it changes its tune further. My estimate is for between 2% and 2.5% growth.

Closing In On Full Employment

I could be wrong about the labor market reaching full employment in 2019. As you can see from the chart below, the percentage of civilians unemployed for 27 weeks and over has been falling sharply in the past few months. The closer it gets to the bottom in 2006, the more likely the labor market is filled. Judging by the speed of this decline, it might be reached in the next few months or in 2019. When the number is in between the 2000 low and the 2006 low, I’ll have little standing to say the labor market isn’t full.

Conclusion

I still think the market is range bound for the next few months. Increased growth in Q3 could bring the market to new highs. However, the labor market might reach full employment in the second half of the year which would really spur inflation, pushing the economy close to a recession and an inverted yield curve. On the bright side, the forward PE is at 16.4 which is very close to 16.1 which is the 25 year average. Valuations are sane again.