An equity chief explains why an unexpected Fed decision could soon burst 'the biggest bubble ever' and send bank stocks skyrocketing
- The demand for bonds amid recession fears has created what might be "the greatest bubble ever," according to Julian Emanuel, the chief US equity strategist at BTIG.
- He says the Federal Reserve now has a timely opportunity to help deflate this bubble, albeit in an unexpected fashion.
- The Fed's move could help send the S&P 500 back above 3,000 and benefit a select group of stocks more than others, according to Emanuel.
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It is not often that a chief US equity strategist calls a bubble in a major asset class.
However, the recent surge in bond prices and the simultaneous plunge in their yields have led BTIG's Julian Emanuel to question whether we're witnessing "the greatest bubble ever."
The market's frothiness was apparent last week, when recession fears caused a stampede into the safest assets and pushed the 2-year Treasury note yield above its 10-year counterpart. This so-called yield-curve inversion - the first since 2007 - is one of the most revered recession signals and it sent the stock market reeling.
Emanuel had wondered whether the bond market was a bubble waiting to pop before this closely watched portion of the yield curve inverted. Following last week's recession scare, and with nearly $17 trillion in negative-yielding debt around the world, he sees an opening for the Federal Reserve to help puncture this so-called bubble.
The Fed would assist by cutting its benchmark interest rate by 50 basis points in September, Emanuel said in a recent note. This move would inject confidence into consumers and investors, and help curb the frenzied buying of bonds.
Most traders don't see the Fed acting this aggressively. On Monday, the CME's FedWatch tool showed the market was pricing in a mere 5% chance of a 50-basis-point rate cut, while the plurality of traders saw a 25-bp cut. This means that if Emanuel's forecast comes true, it would catch the market off-guard based on current expectations.
But such a Fed surprise has historical precedent, Emanuel said, adding that it could be the catalyst that sends the S&P 500 back above 3,000. He recalled that the Fed similarly slashed rates by 50 bp in September 1998 even though the economy was growing at a 5.1% pace.
"As we suggested on 3/31 when we originally made the exceptionally non-consensus forecast that the Fed will cut rates twice in 2019, neither the level of the equity market nor the strength of the economy will necessarily dissuade the Fed from cutting," Emanuel said.
He added, "Stocks, in our view, cannot make material upside progress without the bursting of the Bond Bubble, whose presence (now a staggering $16.7T in negative-yielding debt globally, up from $6T nine months ago represents a profound global crisis of confidence, confidence being the very thing that the Fed is aiming to boost."
By cutting rates aggressively even though data shows the economy is not yet slowing, the Fed would be sending a strong message, Emanuel said. Such a move would steepen the yield curve and help stabilize financial markets.
Emanuel sees financial stocks benefiting the most from a 50-bps cut in September. This group of stocks, captured in the Financial Select Sector SPDR exchange-traded fund, has been crushed by the yield curve's flattening, he said.