To invert or not to invert.

The last few days, the markets have been awash with stories of a looming recession. The soothsayers cast their nets far and wide and the entrails of the slaughtered market revealed the yields on the 3-month -10-year treasury bond had inverted. This was the ominous sign.

Like all ominous signs, this time is not like the previous times. It’s different. That’s what Bernanke said in 2006, and others have said previously. Even the great Bill Gross was fooled at the time. At the time, the 3-month bill and 10-year treasury bond had inverted then flattened and the 2-10 -years were also inverted.

People were quick to dismiss the flattened yield curve as a function of low rates in both the front end and back end of the curve. The yield curve matters because that’s how financial institutions make money. They borrow at low short end rates and lend at higher long-term rates and take the margin. With the curve flat, the incentive is taken away from the institutions and borrowing slows markedly.

However, this time is probably different to last time. Structurally the front end is being manufactured through significant issuance and the longer end is being bought because central banks have the markets awash with money as they attempt to stimulate their respective economies.

For me, the best indicator for recessions is the leading economic indicators and this is especially so in trade, shipping, logistics and advertising. See repricing in those and you have something to be concerned about.

Yes, the yield curve matters and yes, it is a barometer of investors expectations and eventually those expectations may be right. The fact that something happens may only just be a coincidence. The recession of 2008 was not because the yield curve shifted, it was because the financial engineered products bubble burst, leaving many investors scrambling for an exit with only a few escaping.

The start of the week was one of reflection. Stocks have just finished a great quarter.  However, in the Dow, we had a small slump caused by Walgreens Boots Alliance Inc after revenues fell. The drug makers in general were down. Technology stocks improved and carmakers in Europe propelled the Stoxx 600 higher. Even Shanghai rallied.

The event that the markets really care about at present is Brexit. With Britain set to leave the bloc in 10 days-time, Theresa May still has plenty of work to do. With a noncomplying Parliament, it is hard to see how any arrangements can be made.

Stocks want to keep the rally going. The data though is still suggesting some issues exist within the U.S. economy. Durable goods orders were weak, down 1.6% in February (although better than expected). Core capital goods orders fell, and this was unexpected. Transportation equipment was down 4.8%.

The weak durable goods orders release was the stimulus that the bond market needed. The 10-year rallied a few basis points to close around 2.48%. The Treasury market is also reacting to the uncertainty of Brexit.

 

Market Recap.

Equities: The S&P 500 was flat. The Dow fell 0.3%%. The Vix closed at 13.36. The Stoxx Europe 600 Index rose 0.4%

Currencies: The Bloomberg Dollar index gained 0.2%.  The euro fell 0.1%, and the pound gained 0.2%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.476%. The 2-year is trading at 2.306% and the 30-year is at 2.879%. The U.S. curve closed on the day with the following closes 2/10 at 17 bp, 2/30 at 57.3 bp and the 10/30 closed at 40.1 bp. The U.S. 5-year closed at 2.288%. The 2/5 spread is now -1.9 bp. The ten-year bund closed at -0.047% and the British gilt closed at 1.005%. The 10-year yen gilt is trading -0.064%.

Commodities: WTI rose 1.7%. Gold rose 0.3%.

Bitcoin is trading around $4,810 up about 23% over the last month.

 

Aussie Market Today.

It’s a risk on day and expect some excitement in equities today. We could even see a decent rally. The day’s events will be determined by the reaction to last night’s budget.

The Budget appears to be removing a little bracket creep but is not seen as stimulatory in a number of quarters.  Josh Frydenberg has been sensible in his commodity outlook. The iron ore price is much lower than spot. The reasoning is that iron ore is artificially high because of Vale’s collapsed tailings dam and that iron ore will return to its long-term average.

In a political sense, the Budget is aimed at the looming Federal election and it will be interesting to see how the opinion of voters change over the next month or two. Much of the surplus comes from lower cash payments laid a year in advance but these are not identified nor the parameters.

Bonds escaped a bullet yesterday and probably will again today. The offshore markets rallied, and part of that rally is due to uncertainty surrounding Brexit. Expect the market to be range bound.
Geopolitical risks remain high and still need to be monitored.