What Can We Make of This!
The more time that Trump tweets the more time credibility will be questioned. And that is probably the main driver of markets currently. Trump appears to be rapidly becoming a victim of his own making. The geopolitical risks are confusing. First we supposedly have war ships steaming towards Korea when in fact they were steaming away into the Indian Ocean. We then have the issue of Iran where the U.S. appears to be suggesting that they could bomb Iran. That could prove to be a real folly and that probably could happen at the insistence of both Iran and Saudi Arabia, both of whom stand to lose much if Iran becomes part of the global economy again.
As the rhetoric amps up we note that M&A activity has fallen as a result of uncertainty over tax and regulatory conditions and policies. “If IG issuance is dropping due to policy uncertainty, this could easily boomerang back into weaker growth, falling risky assets, and wider credit spreads,” Caprio (Bloomberg citing UBS Report). New issuance has fallen and that is causing some concern as a fall in issuance could signal a slowing economy.
On the policy side however the FX market is leading the way in debunking some of the pillars of Trump’s ideas. Trump’s use and understanding of Macroeconomics 101 appears to forget that FX markets are Brownian in nature, and to expect a strengthening currency and for that currency to remain strong is a somewhat fanciful notion. I guess that comes from always trading in U.S. Dollars and never having to think about thirds. Currency appreciation is a pillar of Trump’s policies and also what is behind his zeal to build a wall. The thought is that the currency becomes the offset and that U.S. firms and customers can purchase products cheaper thus offsetting import taxes. Unfortunately the currency has weakened and U.S. firms face the prospect of much more expensive products and this could severely impact the balance sheets of retailers such as Walmart. The real concern however is what happens if the appreciation that the Republicans promise could be more in the way of inflation. And that means the movement is in the inflation adjusted dollar rather than the nominal rate, and that’s the stuff that worries Yellen and Bankers alike.
So the risks are uncertain but markets are still nervous. The U.S. Treasuries staged a retreat today giving up some of the gains of yesterday but still remain 40 or so points lower than a few weeks ago. The Dow was down about 0.6% and the U.S. 10 year treasury closed around 2.22% up about 5 bp. The U.S. curve developed a few kinks today an steepened slightly. The 2/10 closed at 103.30 out about 3 bp, the 10/30 squeezed tighter by 1 bp, and the 2/30 was out by 2bp.
Gold fell 1%, WTI dropped 3.5%, and gasoline inventories rose 1.54%.
It is hard to make out just what is happening, however markets are extremely nervous and posturing that raises geopolitical risks are not helping. I expect this nervousness to continue for some time yet. Meanwhile the reporting season continues to be mixed and this is acting as a drag on equities. Without any reform announcements equities could start to reprice and that is probably what bonds are already alluding to, and that is why the bonds have rallied so far even adjusting for geopolitical risk. High dividend paying stocks and income assets are back in favour and that’s a story in itself.
Aussie Market Today.
The weakness in commodities and equities remain, and that probably means weaker equities in the Aussie time zone. Bonds could retrace a few points today as the U.S. Bonds retraced a few bp on the day. European bonds were also slightly weaker the 10 year bund was weaker by 4 bp to close at 0.2% and that provides more reasons why Aussie bonds could weaken 5-7 bp on the day.