CHANGES ?

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This week is all about changes. The reader may well ask, well what changes? The answer is simple yet complex.

There is the rush to finish off the Tax Bill this week and get the Bill to President Trump to sign into law. The only problem is that the Senate version differs to the Congress version and the two must be reconciled. Changes. Then there is the issue of the 52/50 majority. The Senate could still not pass the Bill in its format. Changes required.

McConnell does not want any substantive changes. However, several GOP senators are concerned about the deficit blowout of $1.2 tr over 10 years and want changes.  Then others want changes to allow pass through taxes for small business less complex. Changes.  Changes, changes everywhere.

For the Tax Bill to pass, a number of GOP members have to change their minds and point of view and given the deadline is Thursday a lot of convincing must be done in an extraordinary short time. Then we also have the debt ceiling looming in December.

And of course, on December 14 after the meetings of the 12th and 13th , the Fed will most likely raise rates another 25 bp in the short end.  Another change.  The probability is tapped out at 99.9% and at 93%, the market is most certainly looking for a hike in rates in December.

So, with all this noise why isn’t the bond market weakening? In fact, many strategists have the yield curve flattening dramatically over 2018. For instance, the Morgan Stanley strategist has the curve at 10 bp and at that level, a potential shock to the equity market. Inflation remains persistently low. The Phillips curve is not yielding any joy in wages growth and employment keeps growing. Some analysts, including the Fed, have unemployment falling to about 3.5% for 2018. Yet the projections still have low inflation.

What is happening?

Simply put, with central banks investing through their QE activities and the Fed will remain as a net investor. Investors have to invest. European high yield is at similar levels to the U.S. 30-year and the U.S. treasuries are far more liquid and on a risk reward basis look to be better investments. U.S. high yield is tight and that’s probably the reason why investment grade credits just keep grinding tighter.

On a risk reward, they look to be a better investment. Some investors are rotating out of equities and buying bonds in an already crowded out market place. Some of this rotation is due to pre-empting tax changes by companies seeking to invest taxable income by investing in pension funds, and some as a natural change.

So what changes? Probably not a lot for the time being. The risks are compounding but as long as the flood of cash remains there is enough liquidity to soak up any tantrums. That’s why volatility keeps getting tighter. And that’s also why many analysts have changed their view. The models are struggling, and the analysts don’t appear to know how to account for the glut of money.

The issue moving forward is how the Tax Bill, if successfully implemented, will lead to growth in excess of 3.4% in an already crowded employment market. How does a change in taxes lead to an increase in economic growth when the natural instinct for a CEO is to take the money and pay out the difference in increased dividends? How does a tax cut lead to a change in view for entrenched behaviours?

An increase in confidence will help but it won’t push economic growth higher over the medium term. What happens if the growth does not occur and the deficit widens by a larger amount? The bond market in that scenario would be very heavy sellers. What industries naturally increase their growth rate on a tax cut? Yes, the tax cut will spur some growth but to make meaningful changes to the economy, change is required other than tax cuts.

One of the great illusions is with the tight labour market, wages must surely increase. Productivity remains weak, technology is making many middle management jobs and some shop floor jobs redundant and a growth in baristas and coffee shops will not add meaningful amounts to a country’s GDP.

So, what happened on Black Friday? Today, Cyber Monday, looms most likely to be the biggest -ever shopping day in the U.S. Friday is but a mere memory because it was somewhat uninspiring.  Deals throughout November hurt sales. However, more shopping was done via mobile devices this year than last year. Walmart gained on its rival Amazon and looks likely to regain its “low price leader” tagline. Cyber Monday is also gaining acceptance because for those who shop online the taxes are often avoided.

U.S. home sales surged to the highest level in 10-years. New home sales increased 6.2%.

Talks, of Merkel forming a grand coalition with the SPD and Christian Democrats, spurred investors in Europe and led to a more positive tone in the European bond markets. The big gainers were surprisingly the Southern European markets such as Spain and Italy.

Recap:

Equities: The S&P 500 lost 0.04%. The Dow rose 0.10%. The Stoxx 600 fell 0.5%.

Currencies: The Bloomberg Dollar Spot Index gained 0.1%. The euro fell 0.3%.

Bonds: the 2-year rose to close at 1.745. The U.S. 10-year closed at 2.329% a slight fall in yield. The 30-year closed at 2.765 %. The 2/10 closed at 58.3, the 2/30 at 101.9 bp and the 10/30 closed at 43.5 bp. The European 10-year benchmark closes were, gilts closed at 1.25%, bunds at 0.339% and OAT’s 0.51%.

Commodities: Gold rose about 0.4% and WTI fell 1.8%. Copper fell 0.9%. Oil could be in for a shock as the Russian Sakhalin -1 oil output may threaten OPEC deal compliance.

Aussie Market Today.

Aussie bonds will continue to go their own way today and are likely to rally slightly. The market appears to be quiet but steady.

Equity markets will continue to push ahead and continue the rally in light volume.

 

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