Stocks Move Violently As Traders Fear A Trade War & The Hawkish Fed

The best sectors were real estate and communication services as they increased 2.66% and 1.04%. Real estate stocks love low interest rates. So do home builders, as the ITB was up 1.86%.

Financials and energy fell the most as they fell 1.44% and 1.77%. KRE regional bank index fell 0.8%. The yield curve actually steepened. But traders are still worried about the possibility of an inversion and the slowing economy.

Yields Fall & The Curve Steepens

The 10 year yield is now at 2.9% which is a 36 basis point decline from the peak in November. The two year yield is at 2.77% which is a 20 basis point decline from its cycle high. The difference between the 2 yields is 13 basis points which means the curve steepened slightly.

With the two-year yield falling, the Fed’s rate hikes will invert the near maturity portion of the yield curve. Somehow the Fed wants to raise rates to between 3% and 3.25% in 2019.

That would put the two-year yield below the Fed funds rate. Of course, the market would have the two-year yield above 3% if it believed the Fed would hike that much. If the Fed doesn’t change its dot plot at its December 19th meeting, there will be a stock market crash.

Bear market territory would be reached quickly

As you can see from the chart below, the market is now expecting zero rate hikes in 2019 after the rate hike in December. If the Fed stays with three hikes in 2019, it will be way more hawkish than expectations.

Even it lowers expectations to two hikes, it will be very hawkish. On the other hand, it will be tough for the Fed to justify changing its dot plot by more than one hike since the labor market is so strong.

72.3% Chance Of A December Hike

Currently, there is a 72.3% chance of a hike in December. I have wavered on the possibility of the hike in December. Sometimes I think the S&P 500 falling below its November low would stop a hike. Other times I figure the Fed is in too deep to turnaround.

The Fed has been guiding for a hike for months. How could it change its stance just before the meeting? There have been some rumors that the Fed won’t hike, but nothing substantial has changed in the Fed’s rhetoric.

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