The equity market produced another solid day and much of the gain may be attributed to a better perceived outlook for oil and that the economy is growing nicely and just perhaps the 10-year will remain steady at current levels.

It is wishful thinking because the equity models now have 10-years at about 2.90% to 3% and the valuations work.  This is wishful thinking because as economies grow then there is a fair chance interest rates will eventually move higher.

The same old chestnut productivity or lack of, has not been magically whisked away, but one thing the models don’t account for is free money from the central banks. The new normal where central banks hurl lots of free money into the system and everything rallies is about to slow down and eventually stop.

Economic progress will be on its own and interest rates most certainly will move higher and perhaps a lot higher than expected.   That’s why it’s wishful thinking.

Investors have forgotten that much of the asset price movement is a direct result of central banks buying products they would not have bought previously. The Swiss National Bank now has a large equity portfolio and so too the BoJ. In a normal world these central banks and many like them would not hold assets other than sovereign debt, currencies and swaps.

For the moment the dream can persist, but for how much longer? Risk is back on the books and everyone is hoping that the U.S. 10-year holds around 3%. With time, that will be wishful thinking.

With almost three times more issuance, an expectation that central banks will be buying fewer bonds to almost no bonds and a potential deficit blowout should the economy fail to generate in excess of 3% growth, bonds look very vulnerable.

Forget about inflation, that’s just noise. Any slowdown in GDP will have bond traders scurrying away to sell because they know a ballooning deficit has to be funded.  That means even more bonds have to be issued and into a marketplace with fewer participants and less liquidity than what was previously there because of changes in the banking regulatory environment.

When the time comes, who will provide liquidity? The banks can’t.

The markets are not going to unravel any time soon. However, the risks are there, and many investors are just hoping these problems will never eventuate. That may be wishful thinking, only time will tell. A lot of 2018’s returns will be predicated upon a growth rate in the U.S. at 3% or higher and to continue into 2019.

Most analysts have 2019 at a significantly slower rate than 2018 so the challenges are there for investors. The equity investors have hope on their side, the risk on trades are working again and the Vix is now at 19.5. This is a bullish signal for equity.

The bond market today was reasonably steady. The 2-year came off a nine-year peak and the 10-year consolidated. Ten-year bonds have moved 50 bp so far this year. Fed funds are pricing a better than 80% chance that the Fed will hike in March. The short-term market consensus is now pricing or expecting 4 hikes in 2018.

The gap between German and U.S. 10 -year are now at the widest since April 2017. Demand for safe haven assets such as bunds are increasing as the view is that European risks are more balanced and there is a continuing demand for bunds.


Equities: The S&P 500 rose 1.2% The Dow rose 1.23%. The Stoxx rose 0.5%.

Currencies: The Bloomberg Dollar Spot Index fell 0.5%. The euro climbed 0.4%

Bonds: The ten-year sold off to close 2.90%. The 2-year closed at 2.184%.the ten-year bund closed at 0.765% and the UK gilt closed at 1.648% and the OAT closed at 1.009%. The U.S. curve closed 2/10 at 71.5bp, 2/30 at 96.7 bp and the 10/30, closed at 25.1 bp. The U.S. 5-year closed at 2.644%.

Commodities: Gold rose 0.3% and WTI rose 1.7 %. Copper rose 0.4%

Bitcoin is trading around $10,072.64.

Aussie Market Today.

Equities should continue their rally and advance in parallel with global equities.

Aussie bonds are flat to U.S. 10-years. After a bit of consolidation in the U.S. market we could probably expect the same today. I expect some book squaring as we head into the weekend that probably should mean a more positive day today.

The AUD is currently showing some strength against a weaker U.S. dollar.