CAUGHT WITH THEIR PANTS DOWN.

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Markets have had a lot to opine about over the last few trading sessions and the full reality of recent events have yet to play any significant part just yet. Markets became too complacent and focused too much on what the Fed was doing and gave scant attention to a bellicose Trump and just kept buying the market and especially technology.

All this led to complacency that has created markets that have been completely caught off guard. The unfolding tech wreck will most certainly hurt confidence and returns. The extent to which consumers and advertisers turn off data gathering companies such as Facebook is not known yet, but it appears as though significant damage has been done to Facebook’s reputation and branding. This week Facebook was down 11%.

The trade war with China and elsewhere appears to have caught most off guard. Most did not believe Trump and unfortunately that was a mistake. Markets now have to ponder the consequences of a trade war.  That most likely could lead to a slowdown of global growth and a spike in inflation, at a time when either or both would be a disaster.

The U.S. needs 3% to balance its books and fund its deficit.  In a trade war, a number of major U.S. companies would be hurt and so too many farmers.

The U.S. has already imposed some tariffs on Korean steel with more tariffs to come. Also, in tune with the trade war, Trump is now surrounding himself with hawks and seems hell bent on causing a confrontation across several fronts. Much of the commentary is ill considered and is not without dangers that could lead to confrontations with Russia and possibly China.

Markets just did not think Trump would willingly go into a trade war.  Nor were they expecting Trump’s comments about the Debt Ceiling and the Omnibus Spending Bill needed to ensure the U.S. Government is funded until October. Trump has vowed to sign a bill like this again and said he would use his veto. Strong words. The main issue was with the funding of the wall which in Trump’s mind is necessary for defence. Defence from whom?

The Facebook fiasco could possibly be the last straw. Advertisers are bolting away and for investors the easy trade of investing in technology may not be so easy now.

The unfolding trade war between China and the U.S. is very much in bond investors minds. China owns about 20% of the U.S. treasury market and has suggested that it may slow or cease purchases. Such a gesture would have an immediate effect and cause bond rates to rise leading to higher interest rates, higher mortgage rates and higher borrowing costs for business.

Such a move would also force a number of other major counterparties to re-evaluate their holdings as the growing deficit and a slowing economy would come sharply into focus.

The ECB announced Friday that they would raise the lending cap on how many bonds it will lend to investors. This paves the way for the ECB to normalise rates and allow investors to more actively trade bonds and push bond rates to more sustainable levels.

Investors like stability and knowing what to expect.  This is simply not happening. Many investors are also voting with their feet and investing in Europe and elsewhere. International funds are attracting major inflows at the expense of U.S. centric funds. To date $19.4 bio has been invested in actively managed non-U.S. stock funds.

Volatility is rapidly increasing at the expense of market gains. Risk off appears to be the direction of markets and bonds are rallying as Trump ratchets up the rhetoric.

Recap. 

Equities: The S&P 500 fell 2.1%. The Dow fell 1.8% and the Stoxx 600 fell 0.9%. The Vix closed at 24.87, a rather uncomfortable level. The S&P fell 5.9% for the week and the Dow fell 5.7% for the week.

Currencies: The Bloomberg Dollar Spot Index fell 0.3%. The euro fell 0.5%.

Bonds: The ten-year closed around at 2.82%. The 2-year closed at 2.258% and the 30-year closed at 3.062%. The ten-year bund closed at 0.527 and the UK gilt closed at 1.447% and the OAT closed at 0.759%. The U.S. curve closed 2/10 at 55.6 bp, 2/30 at 80.3 bp and the 10/30, closed at 24.6 bp. The U.S. 5-year closed at 2.60.

Commodities: The WTI rose 2.5%. Gold rose 1.4%. The divergence between gold and silver is now at 82 times and 27% more than the 10-year average. For some, this divergence is seen as a market indicator of the broader economy and is viewed as a somewhat bearish signal.

Bitcoin is trading around $8,612.5.

Aussie Market Today.

The Aussie equity market will be weaker on the day as the day appears to be a risk off trade.

Bonds are likely to rally as investors look for stability and a safe haven. This rally will be transitory as the trade war impact is unknown at this stage. It is too early yet to measure the impact and the tough talk made by the Trump Administration won’t allow markets to settle easily.

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