Today was a pause-to-think day. The sort of day when you have had a rough week, had a drink to calm the nerves and think about what may have been and finally get some time to regather your thoughts. The holiday spirit continued little as bond investors paused and took a little bit of profit. Well, those that could did.
With another auction of some $230 bio this week investors will have to weigh up if the selloff continues or if this is a good time to buy. There is plenty of stock for all. And it’s this conundrum that investors must now weigh up. Can U.S. rates move significantly higher? And there are plenty of reasons why bond yields can move higher. And if they invest now, their portfolios could suffer further losses, or do they sit tight until bond yields level out? It’s a hard decision. Bonds at these levels look attractive and they now provide a healthy alternative to high dividend stocks. The equation is balancing.
The U.S. has the global markets on a knife edge because the administration feels hard done by on trade. The IMF cut its global growth forecast the first time since 2016. The Chinese trade tensions only look like escalating after it was revealed that in August a very special microchip was found in Super Micro Hardware’s chips. These chips were made in China and it is believed that the Chinese military had those microchips inserted allowing hacking of Super Micro’s servers. If true, this will only raise tensions leading to further tariffs and quite possibly China devaluing the yuan in response to weaker economic conditions as the Government attempts to stimulate the economy.
Banks in Hong Kong are aggressively cutting property valuations in response to weakening housing market conditions. The response by the banks may also be partly due to concerns that the Chinese economy could be slowing and that as the yuan weakens this will cause the Chinese officials to ease more and relax lending conditions.
So on the day, equities staged a kind of revival after being down quite a way at one stage. Tech came to the rescue (outside of semiconductors) and saved the day. We saw a little bit of bottom fishing as well. The Nasdaq 100 index which lost 4% over the previous three days clawed back 1% whilst the day did not end so well for materials which were down as a sector 3.4%. Even the Stoxx managed to find some joy and rose the first time in four days.
In a sobering report released by SocGen, the authors warn investors to check their hedges as volatility is expected to rise in line with the expectation of rate increases. The authors conclude that a resurgence in sharp price movements will create an upward trend in volatility and that the status of American stocks as a safe haven are diminishing. They argue that the benefit of the tax cuts will fade in 2019 and revenue growth will also slow at a time when the Fed is hiking rates (4 in 2019).
S&P has joined Moody’s in expressing concerns over the record high leverage in U.S. companies and warn of possible downgrades and defaults if the current economic expansion slows. The sectors that are seen most at risk are oil and gas, and retail.
Christmas came early for those traders trading BTPs (Italian bonds). The Economy Minister Tria pledged to do whatever was necessary to restore calm. In late trading, yields rallied some 21 bp and the 30-year closed at 3.96% after having broken 4%, the first time since August 2014. The 10-year fell from 3.71% earlier in the day to close at 3.52%. The all-important bund/BTP 10-year spread closed at 297 bp after being at 312 bp, the widest level in 5 years.
But let’s not be despondent with all this negativity. There is a possible silver lining but perhaps not in the U.S. markets. Stocks, high yield and emerging markets suffer as the cost of money rises and financial conditions tighten. Just because the bond bears appear to be winning does not mean other asset classes cannot perform. There are lots of reasons why rates and bond yields in the U.S. should inevitably rise. However, if the U.S. economy is close to peaking then rates won’t rise as quickly as expected and inflation will be tamed and the economy slows. This will provide opportunities.
Markets are reeling from the heat of the Fed’s actions and this will create opportunities.
Equities: The S&P fell 0.1% and the Dow fell 0.21% while the Stoxx rose 0.2%. The Vix closed 16.18
Currencies: The Bloomberg Dollar Index fell less than 0.1% while the yen climbed 0.3%.
Bonds: The ten-year closed around at 3.204%. The 2-year closed at 2.889% and the 30-year closed at 3.365%. The ten-year bund closed at 0.546% and the OAT closed at 0.886%. The U.S. curve closed on the day with the following closes 2/10 at 31.4 bp, 2/30 at 47.5 bp and the 10/30 closed at 16 bp. The U.S. 5-year closed at 3.052%. The curve flattened about 3 bp today.
Commodities: WTI rose 0.8% while Gold gained 0.2%.
Bitcoin is trading around $6,575.
Aussie Market Today.
The ASX is likely to remain nervous. The Asian selloff will only heighten fears. Bonds appear to be on a negative trajectory and that will hurt equities for the moment. Asia looks likely to continue the selling and that will make it hard for the ASX to rally. Korea is out today.
Bonds should be steady for the day. With new funding this week in the U.S. and a nervous bond market, it’s hard to be positive. The bears appear to be firmly in control. The global trend is one of weakness and unless something material happens, the trend of weakening bond prices looks likely to continue for a little while yet.
On an interest differential basis and weak commodity prices, there does not look like much respite for the Aussie short of intervention by the RBA. I expect the weakness in the Aussie to continue.
Geopolitical risks remain high.