On the Friday before Memorial Day markets close early, and the whole week is usually a snoozer, Wall Street big shots already headed for the Hamptons to kick sand on weaklings.

Surprise! And not just one... too many to count.

In the biggest effect of all of the surprises, long-term rates have come down -- a classic reversal of “everybody knows.” Everyone has known that long-term rates are going up. Not this week: the 10-year T-note fell to 2.93% today, down from the spike to 3.11% just seven trading days ago, and puling mortgages near 4.75% or lower.

Maybe a whole bunch of money decided to play it safe, buying bonds before a long weekend, a temporary thing. But several surprises have acted in concert.

Tops, today: the Saudis and even Russia are suddenly loosening the hose-clamp which had taken oil to the mid-$70 range, headed for $80-plus. An oil cap would limit the inflation risk which oil had added to the previous rise in long-term rates. Why would the Saudis and Russians ease up? So that prices do not spike and encourage new supply and conservation. Every drug-pusher knows that.

Right behind that surprise... European structural weakness is back in play. Its best overall economic indicator in May ker-plunked to the worst result in 18 months. Italy is again behaving like Italy. Brussels is behaving miserably to Brexit, making it as hard as possible as a warning to any others tempted to escape -- this week interfering in resolving the border between Ireland and the UK North. In a heavy German accent.

An essential global indicator is the yield on German bonds. Back in 2016, the ECB madly buying IOUs, German 10s were stuck below 0.20%. Since then, in the warm glow of pretended European recovery and potential ECB normalization (its overnight rate is still negative .4%), German 10s made it to 0.71% by February, dipped a little and back to 0.64% two weeks ago. Today, 0.40%. Plunging by one-third is big stuff, and pulled our 10s down, too. Some of the German drop is due to those new stresses in Italy, its 10s soaring to 2.54% -- in the same currency, same central bank.

The Trump administration this week contributed its surprises. On Monday it threatened to impose tariffs on imported cars, in continuing misuse of Cold War national security authority granted to the president by Congress in 1962. Tariffs and taxes are the business of Congress, not presidential orders. Tariffs on cars is the worst trade-war idea yet. But, just to keep everyone guessing, we have let China win our trade war with them, and the president proposes a free pass for China’s thieving ZTE, bi-partisan objection in Congress.

The North Korea summit... our side thought we were meeting to accept their surrender. Get the Missouri out of mothballs, let Kim sign on the quarterdeck. If North Korea intends to pursue economic integration and health, and to pull away from nuclear confrontation, the internal consequences in the DPRK will require delicate work. After three generations of Kims, subordinate leadership will have to find other work, and its people adjust to a new world. Isolation does wild things to societies -- google “DPRK juche” for a glimpse. East Germany was run by Soviets for half as long, and the East still struggles to re-integrate.

Then there is the Fed. Some say that US rates have dropped because the Fed is packed with doves and policy is too easy. Others say the Fed is too hawkish and rates are falling in anticipation of an economic slowdown or recession.


The Fed could not be more clear. Its forecasting tools have failed to work for a dozen years, which it knows. It is always “data dependent,” but when it uses that phrase today the Fed is saying that it’s reacting from one economic report to the next. All data say that the economy is healthy enough for the Fed to raise the cost of money to a normal level relative to inflation. From today’s 1.75% Fed funds to something 2.50%-3.00% by the end of 2019.

However, if your best foresight is tapping ahead with a white cane, better go slow. If you sense an edge, stop.

Next Friday we get employment data for May, more likely to be strong than weak. 2nd Quarter GDP is going to grow in the 3.5%-4.0% range. Tap, tap... no edge.

The Fed’s next meeting is June 13, and it will hike from 1.75% to 2.00%. The big question then: what happens to other, longer-term rates? In the last month, any time 2s have risen so that the spread to 10s has closed to 45bps, 10s have popped up. After the 13th, 2s up, 10s not so much, narrowing spread? A warning of Fed overdoing. Spread constant, tap-tap-tap on ahead.

The Fed plans a third hike this year, but we’ll get a tremendous amount of data between now and fall. The Fed could stay on track, accelerate, or stop altogether.

The odds of a continuation of this week’s drop in rates to lower levels? Very poor. 10s face tremendous resistance at 2.90%, and the drop this week feels as though caused by unusual and largely overseas events, not trend-change.

The 10-year in the last year. The sharp drop this week is plain, as is remarkable stability since February, “resistance” to lower:

The 2-year T-note is peculiar -- the long upward march consistent with the Fed’s intentions, but the drop this week...? Maybe oil settling down. Maybe too many traders had expected a fourth hike this year, gave that up? Indicating a stop to the Fed’s normalization? No:

Too strong for the Fed to pause: