Jerome Powell gave his testimony today and in some ways, he did not disappoint as he was predictable in what was said. The U.S. economy is growing, inflation is stirring, wages are potentially increasing, and all is good, just four hikes required over the year to keep the economy on a growth trajectory and inflation under control. So why did equities and bonds sell today?
Maybe equity markets were looking for only three rate hikes? Almost certainly there will be a rate hike in March, this hike has been well anticipated with Fed Funds Futures at almost 100%. So, a rate hike was not the answer. Maybe the company reports are indicating a slowdown. That’s not the answer because most are showing better results and that’s partly due to the tax cuts.
Could be dividends? Maybe but so far 20% of S&P 500 companies have increased dividends, that’s not the answer. For the first time since September 2008, a U.S. 2-year treasury is paying more than dividends from the S&P 500.
Maybe it’s the magic number of a 10-year treasury trading through 2.9%. Maybe Merrill Lynch and Credit Suisse researchers were right in announcing the 2.90% level as a portent to future movements.
What we do know, however, is that for one very large investor, Japan, the U.S. treasury market no longer holds a strong appeal. You see, the Japanese are selling U.S bonds because they are fearful of deficits and don’t believe Mnuchin and his assessment of the U.S. dollar. Faith in the dollar has eroded. Japanese investors in the last three weeks sold some $19.6 bio of bonds and sold about $34 bio in the December quarter.
The dollar has fallen some 5% against the yen so far this year. A weak dollar and high interest rates in the U.S. should provide buying opportunities. However, at current levels, investors remain wary. The concern for the investors is where is the money going to come from to fund the deficit and there is the possibility of inflation. The Japanese have been investing in Europe and emerging countries such as India.
What could attract Japanese investors would be to see bond yields above 3% and stabilised around that level. Such a level could be a red flag for equity investors. Markets are twitchy and are likely to remain that way for a while. A sign of twitchiness is the repo rate is climbing a little and the Vix is trading around 18.6. Volatility once again is making an appearance. European bonds sold off ahead of Powell’s comments and the bearish tone appears to be continuing.
For the Trump Administration, this should be a flag to be a little cautious. For exactly the same reasons that drove Clinton to pare back the deficit, the appearance of the bond vigilantes could upset policy and policy making. A true test is possibly looming.
Political intrigue could also lead to investor instability and we are likely to see more rather than less intrigue over the coming year. The play between Kelly and Kushner looks likely to escalate after Kushner’s security clearance has been downgraded.
Equities: The S&P 500 fell 1.27% The Dow fell 1.16%.
Currencies: The Bloomberg Dollar Spot Index rose 0.5%. The euro fell 0.7%
Bonds: The ten-year closed around at 2.89% after trading through 2.91 earlier in the day. The 2-year closed at 2.26% and the 30-year closed at 3.16%. The ten-year bund closed at 0.676 and the UK gilt closed at 1.52% and the OAT closed at 0.949%. The U.S. curve flattened on the day and closed 2/10 at 63.1bp, 2/30 at 89.8bp and the 10/30, closed at 26.4 bp. The U.S. 5-year closed at 2.664.
Commodities: Gold fell 1.2% and WTI slumped 1.5 %.
Bitcoin is trading around $10,665.
Aussie Market Today.
Equities in the U.S. sold and that selling is likely to influence the Aussie equity market. Expect some profit taking and selling on the day.
The AUD is likely to be a little weaker as the U.S. dollar is slightly stronger, and commodities were a little weaker overnight.
Bonds could have a patchy day. Expect some selling. However, with the U.S. 10-year selling then rallying, Aussie bonds may be more comfortable with a slight rally. Expect a slight back up before seeing some buying. The AUD 10-year is now 10 bp through the U.S. 10-year.
Higher rates in the U.S. are not proving that attractive yet for international investors hence the Aussie bonds can probably rally on from here, especially if the Goldilocks period continues.