NEVER-NEVER LAND? Where, curiously, bonds always rally

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Never-never Land. Is a Land where, curiously, bonds always rally. Over the last month, bonds have once again become conjoined at the hip with equities and have a causal correlation that defies the textbook description of how markets work. When equities rally bonds rally, they are suppose to weaken. When equities sell bonds rally. This defies logic especially as we know that QE is coming to an abrupt end shortly as the Fed prepares to begin reducing its $4.5tr balance sheet.

So, what has happened? The Fed’s inflation indicator is at 1.4% well below its target of 2%. Trump’s feud with Lil’ Kimmie appears to ebb and flow especially as Trump has threatened to beat him up if he comes out of the hood. So maybe some geopolitical risk. Or maybe it is just that there is so much money sloshing around as central banks around the globe continue to purchase bonds as they try to reflate their economies.

Or simply QE does not work, putting money back into major corporates simply means those corporates and ultra-wealthy invest that money without investing in capex and that does not lead to growth. The free cash has meant corporates have borrowed to increase dividends and buy back stock and that does not lead to growth. The employment queues tell us that already as many jobs are being created in low value jobs rather than high value jobs. Maybe that’s what is happening.

Anyway, August has been a good month for bonds. The Bloomberg Barclays U.S. Treasury Index is up 0.95% for the month and the S&P 500 is barely up 0.2% including dividends (Bloomberg).

The weight of money is certainly driving the bond market at present. The other issue I believe is that bonds don’t see much chance of Trump’s tax plan amounting to much. Trump’s team to date have released few details and when Congressmen on both side of the aisle are interviewed they all complain about a lack of any detail. With Trump attacking his own party and the Democrats, it is hard to see how any unity will be achieved. The old CEO 101 of divide and conquer appears to not be working.  The mixed messages on the economy and geopolitical front are also confusing investors. The key for the tax plan is go beyond the 10 years so that businesses have clarity. To do that they need 60 votes that may be difficult. With 52 votes Congress can change taxes but those changes have a 10-year limit. I think that is what Trump will go for.

Meanwhile the debt ceiling time bomb is ticking away.

Brexit talks today appeared to be falling down. The third meeting basically accomplished nothing leaving the EU representatives somewhat disappointed with the UK negotiators. The pound suffered accordingly.

Mnuchin has suggested that the debt ceiling could be pushed forward sooner rather than September 29. He sees providing relief for victims of Hurricane Harvey as being the catalyst.

U.S. consumer spending rose slightly less than expected and annual inflation advanced at its slowest rate in more than 1-1/2 years. Consumer spending was up 0.3%.

Recap:

U.S. 10-year bonds rallied to 2.12%. Treasuries have rallied some 17 bp over the month. The probability of a rate hike remains steady at 28% in December 2017 and 49.6% in June 2018. Interestingly the probability of a rate hike between now and September 2018 is below 50%.

The Dow rose 0.25% and the S&P 500 rose 0.6%. The Stoxx 600 rose 0.8%.

Commodities saw gold rise 0.7%. WTI crude gained 2.8% and gasoline was up 14%.  Base metals were strong with copper advancing 0.4%. Speculative buying of the metal out of China is the primary driving force. China accounts for nearly 50% of global copper demand at 23 million tonnes. China is also the primary driver for the other base metals. Much of the demand is as a result of China’s newly introduced antipollution laws. Nickel, aluminium, and zinc are all seeing strong interest out of China.

Aussie Market Today.

Today could be an unusual day. As bonds rallied little overnight the bonds are likely to be slightly better bid, however the odds are that bonds could sell off Friday. I expect bonds to drift weaker. Equity should rally a little. Be wary of any announcements of a regulatory nature concerning the Australian Banks and especially the CBA. If the Wells Fargo Bank is anything to go by, the CBA has similar cultural issues and that could be a concern to regulators.

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