CONSENSUS VERSUS EXPECTATIONS.

That’s how the markets are reacting. The equity market is full of hope and expectations. The equity market sees the tax cuts as positive and it’s not so much that Joe Average has more money in his pocket and it does not mean Joe is going to consume much more.

What it does mean is that companies will be paying out larger dividends and launching larger share buy backs both of which are supportive of strong equity markets.

The next thing equity markets will be doing is parsing Jerome Powell’s comments about the Fed’s positioning. Jerome of course will say that he is concerned about inflation because of wage inflation and that the economy will grow at 3% and that’s supportive of expectations and a stronger market. What Jerome won’t say is much of the wage growth is not due to productivity gains and much of the recent spike in wages was of course coincidental as 17 States mandated wage rises from $8 per hour to $11 per hour.

Bond investors, on the other hand, are largely positioned by way of consensus. They are all expecting bond yields to rise, have massive short positions on the 10-year but bonds keep rallying, why? That’s because everyone is basically short, and we are seeing some short covering.

Asset allocators, hedge funds and traders are all short. However, the market for the moment is rallying. The balance of risks is shifting. Bond investors at present are not fearing inflation so much as increasing deficits and increased issuance. For the moment however, the bond investors have not crowded into wrong way bets. Markets, however, have a habit of changing quickly.

The current narrative is that we have synchronised global growth, tighter monetary policies, and higher wages and inflation. The last two are very debatable and in reality, growth is the only thing that economists can point to. Wages growth remains sluggish and productivity is not rising. The wages narrative is interesting because many countries can point to low unemployment rates. That’s because many jobs are now either consultants, gig employees where there is no pricing power.

In places like Australia, wage growth remains sluggish despite low unemployment rates. BHP has voiced an opinion that it wants to reduce wages in a tight labour market. That can only be done when workers have no pricing power. Many construction workers for example are on 457 visas and, under those arrangements, are on lower wages than domestic construction workers.

Once the project is finished, these workers often then move into the domestic market and are happy to accept lower wages. The U.S.,  like Australia, has a low unemployment rate and for many like Australia there is a high rate of part time work and wage pressure coming from other workers, holding wage pressures at a lower level.  The steady stream of low wage earners entering the U.S. assists to keep productivity reasonable and wages low.

This is the reason why many Japanese investors have been shunning the U.S. treasury market of late. These reasons combined with a weak U.S. dollar has made investing in the U.S. unattractive. If, for example, a number of other investors arrive at the same decision, then the shorts in the U.S. 10 year will prove to be productive.

The point is that inflation caused by wages will remain sluggish. Tax cuts won’t significantly alter the status quo and the real concern for markets will be if the U.S. economy fails to exceed 3% growth and the deficit balloons.

For the moment, the U.S. 10-year looks attractive compared to bonds elsewhere. The U.S. economy is growing steadily at around 2-2.5%  and the environment looks attractive for investors, but how long can this continue? That’s where expectations and consensus come to play.

The U.S. does have its fair share of political intrigue at present, hence politics looms large. A crisis appears to never be too far away. In the meantime, we await Powell’s testimony tomorrow. Bonds rallied as shorts were cut in preparation for Powell’s testimony whilst equities reacted to falling bond yields. However, don’t get too complacent just yet.

Hedge Funds and traders apparently have the largest short-term bet on higher U.S. interest rates. Traders are also rebuilding their bets on volatility, a clear sign that the Goldilocks period may be coming to a close. Many of the new bets are now bearish. Net shorts in Eurodollars are rising and now at a record 3.675 mio contracts. Investors are chipping away at the record long position in the Vix.  Markets are delicately poised.

 

Recap.

Equities: The S&P 500 rose 1.2% The Dow rose 1.58%. The Stoxx rose 0.5%.

Currencies: The Bloomberg Dollar Spot Index was flat. The euro rose 0.1%

Bonds: The ten-year rallied to close at 2.86%. The 2-year closed at 2.23% and the 30-year closed at 3.156%. The ten-year bund closed at 0.65% and the UK gilt closed at 1.51% and the OAT closed at 0.93%. The U.S. curve closed 2/10 at 63.2bp, 2/30 at 92.5bp and the 10/30, closed at 29.1 bp. The U.S. 5-year closed at 2.61.

Commodities: Gold rose 0.4% and WTI rose 0.7 %.

Bitcoin is trading around $10,376.

Aussie Market Today.

Equities in the U.S. finished with some squaring of positions ahead of Powell’s testimony. That could lead to some profit taking Down Under. The Aussie equity market should open with some strength and continue into the afternoon with perhaps some selling towards the close.