ENDURING OR ENDURANCE.

Markets on Friday continued on the track of risk off. Bonds were stronger and equities weaker. At the heart of the problem were the geopolitical risks that were heightened later in the week at the instigation of Trump and his Administration. North Korea remains problematic and somewhat subdued. The tariff spat with China appears to be settling.

Where the problem lies however is with allies of the U.S.  The U.S. has antagonised its allies through bullying and the threat of tariffs on goods should they have an alternative political view. Europe’s treatment of Russia and Iran come to mind.

The other factor that has caused the rally in bonds is the state of the U.S. economy. And this is where everything becomes tricky. Durable goods orders were released Friday, and this does not make easy reading. With the much touted tax cuts and the belief that business will reinvest is proving – just like previous times this has occurred – to be a myth.

Over the last six months investment in capex has remained subdued whilst payouts of dividends and share buy backs have increased. The University of Michigan consumer sentiment index slipped to 98 from 98.8 in April.

Orders for long lasting equipment fell 1.7%. The demand for transportation fell 6.1%. The fall in durable goods on major equipment shows how fine a line the U.S. economy is treading. The imposition of tariffs would be a disaster given the lack of capex spend. All a tariff on steel, for example, would allow is make those companies terminal quicker.

The reasoning being that overseas companies will have to become more efficient and productive if they wish to compete in the U.S. That means they will be spending on capex and will be making a profit where U.S. companies are struggling. It is interesting this is exactly how NUCOR became a behemoth. It invested in capex when many U.S. steel companies rubbished new technology and new methods of production and in that failure eventually went broke. Interestingly, NUCOR is leading the charge for tariffs.

In essence, the U.S. economy requires a productivity boost and that requires capex. The economy also appears to be slowing and that is bad for funding and the deficit which looms large if the economy does not grow at 3%. Wages cannot grow if productivity does not increase.  Wages are also suffering from the internationalisation of employment.

One can use an accountant in Malaysia to do the books for a business in the U.S or a radiologist in India can be reviewing information whilst a surgeon is operating on a patient in Mt Sinai Hospital in New York. This change in the workforce is making it difficult for wages to push higher.

Geopolitics are driving bond markets and the Italian experience is certainly problematic in Europe. Italy continues to confound with the Italian President blocking the formation of a new government on the basis that the coalition could endanger Italy’s membership in the single currency.

Italy’s 2-year bond climbed 30 bp on Friday to close 0.67%. A week ago it was about 0.0%. Bunds rallied in response. The 10-year closed at 2.46%.

Meanwhile, Europe and the U.S. continue their own trade spat.  A comment by a senior French diplomat sums up the feeling in Europe: “The question is how can we accept a situation where the Americans manage their dialogue with a rival like China the same way as with their allies without special treatment for being a U.S. ally?”

In a Reuters poll conducted between May 16-24 of 100 economists,  economic growth was expected to lose momentum in 2019, with some 30% believing a recession in the next two years was possible. Most economists had growth for 2018 at 2.8%, slowing to 2.5% in 2019 and 1.8% in 2020.

In other news, the Saudis and Russian appear to have made an agreement over the supply of oil. It would appear that the noose around supply has been eased and that production will increase. The oil price has adjusted.

Recap. 

Equities: The S&P 500 fell 0.2% The Dow fell 0.3%. The Stoxx rose 0.1%

Currencies: The Bloomberg Dollar Index rose 0.3% The euro rose 0.5% and the yen fell 0.2%.

Bonds: The ten-year closed around at 2.93%. The 2-year closed at 2.476% and the 30-year closed at 3.09%. The ten-year bund closed at 0.405% and the UK gilt closed at 1.324% and the OAT closed at 0.71%.

The U.S. curve closed the day with the following closes 2/10 at 45.1 bp, 2/30 at 61.2 bp and the 10/30 closed at 15.9 bp. The U.S. 5-year closed at 2.76%.

Commodities: WTI rose fell 4.4% and Gold fell rose 0.3%

Bitcoin is trading around $7,335.

Aussie Market Today.

Equity markets Friday were a tad weaker and bonds a lot stronger. Today should see a reversal. Trump’s willingness to meet Kim Jong -un and a hold on trade barriers with China diminishes geopolitical risk a little. I expect the equity market to rally a little.

Bonds should weaken a little.  However, with uncertainty hanging over the U.S. market, it probably won’t go too far.