It isn’t very often that we hear about investment banks issuing warnings about the overall market. Because the big brokerage firms need investors to believe that the market is going to move higher, they tend to have pretty rosy outlooks most of the time. That’s what made Monday somewhat unusual as two different investment banks made statements about the market and the economy that were rather bleak.
One comment came from Citigroup and its Global Macro strategy team. The team wrote in a note to clients, “Tensions are mounting and the outcome looks more likely to be driven by politics than economics. President Donald Trump is likely to continue to take a hard line.”
The note went on to state that unless the Fed cuts interest rates it sees a “full scale bear market” for the S&P 500 with a drop of 20% or more. The team also predicted a drastic drop in 10-year treasury yields to 1.5%, and a surge in gold prices to $1,600.
Citigroup’s team expressed concern over trade tensions with China, but also with increased tensions between Europe and Japan.
The interesting thing is that Citigroup’s position is that the bear market could be avoided if the Fed cuts rates, or at the very least curtailed.
That brings us to the second notable statement from an investment bank on Monday, and that one came from Goldman Sachs. The bank doesn’t expect the Fed to cut rates for the rest of 2019. Jan Hatzius, the bank’s chief economist, stated, “Although it is a close call, we still expect the FOMC to keep the funds rate unchanged in the remainder of the year.”
Obviously, the Goldman view goes against the consensus right now. As I expressed in an article on June 6, Fed Funds futures are now priced such that there is a 70% chance of a cut in July and a high probability of multiple rate cuts before the end of the year.
The market has bounced back in the last week or so as investors took comments from Fed Chairman Powell to be more dovish and that helped stocks recover from a rough may. If Goldman turns out to be right and we don’t get a rate cut in July, look out below because stocks will drop and they will drop hard.
Of course, the wildcard here is the trade war between the U.S. and China. If a deal was to be reached between now and the July FOMC meeting, that could change the entire landscape. Stocks will likely rally once a deal is announced, and if there is progress made at the G20 meeting later this month, we could possibly get a handshake deal before July 31.
I guess I fall somewhere between the views of Citigroup and Goldman. I see the Fed making at least one rate cut this year, but that might not be enough to keep equity risk levels from what I see as an elevated state. I think it is highly unlikely we see a trade deal in the next month and a half, but I do see one happening before the end of the year. I think the pressure will increase on both sides to get a deal done. There is too much at risk as the dispute wages on.
While the negotiations are strictly between the U.S. and China right now, the consequences could impact the entire global economy. There are also the potential negotiations between the U.S. and Europe and the U.S. and Japan. It could be that President Trump is taking the hard line stance with China in order to prove a point. If he is seen as coming out as the winner, he sets the U.S. up for easier negotiations with the European Union and Japan.
Regardless of the outcome of the trade war, the uncertainty is certainly causing different opinions and reactions from investment banks. I have been following the market for approximately 30 years now and I don’t ever remember two investment banks making such pessimistic and opposite comments on the same day.