DIGESTION PROBLEMS?

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Today saw the short term borrowing costs of the U.S. government rise to the highest levels seen since 2008. About $179 bio was issued with a further $$35 bio of 5-year notes and $28 bio of 7-year notes to be issued.

This is only just the beginning of what needs to be issued this year in the Government’s quest to borrow some $1.2 tr of bonds, up from 2017’s issuance of about $550 bio. The market is already adjusting rates higher.  This trend is likely to continue for a while as supply will look set to dampen buyer’s enthusiasm for fixed rate notes.

For the equity market the days of easy money low cash rates. At around 3% for the ten-year bond, the equity market looks able to hold current levels and perhaps even prosper. However, investors will be looking for more from companies as they look towards company results. It will become important for investors in companies to see earnings growth rather than multiple expansion to support higher valuations.

Investors will indeed be wary. As borrowing costs rise, the costs of borrowing for companies will be increasing. So too that of the Government which may be forced to borrow additional amounts if the Trump tax cuts don’t lead to any significant growth in the U.S.

And this may be the conundrum that bond investors will have to face later in the year. Mounting debt, mounting borrowing costs and an economy that may fall short of expectations. How the Fed handles all of these factors and keeps inflation at bay will be important as the outlook looks to be rather tricky.

And its not only the Fed that has a restive bond market. The ECB has similar problems to stop bonds overshooting on an expectation that the ECB is likely to slow its purchases soon. ECB bonds are edging higher as investors expect the ECB to take a more hawkish view. If Weidmann is elected, then we could see the stimulus stop sooner rather than later.

The overall trend however is that rates and bond yields will rise over the year, equity investors will become more interested in earnings rather than multiples. As a result, markets are likely to experience a lot more volatility than we have seen over the last two years and especially so in 2017 when volatility ran to an all-time low.

Equity markets today started off on a solid foot. However, as the ten-year edged closer to the 2.90% level, the market became a tad concerned. The catalyst for the sell off, however, was not bond related.

It was due to Walmart. Walmart stumbled as it reported weaker than expected earnings as a result of stronger competition from online giant Amazon. Walmart’s result set off a trigger that saw other retailers such as Gap, Target and Macy’s all lower.

Recap.

Equities: The S&P 500 fell 0.58% The Dow fell 1.01%. The Stoxx rose 0.6%.

Currencies: The Bloomberg Dollar Spot Index rose 0.5%. The euro fell 0.6%

Bonds: The ten-year rallied to close 2.888% after trading at 2.90%. The 2-year closed at 2.22%.  The ten-year bund closed at 0.734% and the UK gilt closed at 1.58% and the OAT closed at 1.001%. The U.S. curve closed 2/10 at 66.3bp, 2/30 at 92.8 bp and the 10/30, closed at 25.  bp. The U.S. 5-year closed at 2.626.

Commodities: Gold fell 1.3% and WTI rose 0.1 %. Copper fell 1.8%

Bitcoin is trading around $11,715.65.

Aussie Market Today.

The Australian markets should see equities weaker.  Bonds should trade a little stronger on the day after possibly seeing a small spike initially. Bonds appear to be settling into a trading range and current levels appear to be around the top. However, as sentiment changes then one should be aware that levels will need to be reset.

 

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