OFF, ON AGAIN?

After the euphoria of the possible meeting between Kim and Trump wore off,  the markets settled down quickly to try and digest just what Trump’s tariffs would mean for the U.S. What we do know is that the pipeline builders are not happy because a tariff would add hundreds of millions to building pipelines.

The oil extraction businesses and chemical producers are also upset as the tariff would be imposed on badly needed high quality steel.   The car industry also would feel the weight of an imposed tariff. Today, however, the equity market focused on some of the companies that would be hurt by the tariffs.  Both Boeing and Caterpillar saw large declines on the day.

The consumer has yet to see the transfer towards inflation and with time that will come. So today for equity markets, investors were rather circumspect and sold. And for those who use bitcoin as a barometer of markets and a signal when to buy or sell, the trend is very much lower. Bitcoin fell to $8,862.  Bond markets were not quite so by today’s events.

What bond investors have to ponder is why bonds are not breaking through 3%. Today, bonds rallied a little but whether they remain bid, only time will tell. There are 10-year and three-year auctions looming and should demand be weak then bonds could sour, and prices driven lower, and yields could press towards 3% again.

The problem for many bond traders is that over the last ten-years markets have exhibited few bearish traits.  And volatility has generally fallen to where it was at one stage totally benign. That may be about to change.  The challenge for many new participants is that most have not traded or invested in a bear market and many are about to see what volatility does when things become volatile.

For many of the bond investors, the perfect storm is being created. Investors have been lulled into a false sense of security through low volatility caused by massive amounts of central bank money which is now being slowly withdrawn and a possible increase in consumer led inflation as a result of tariffs.

Company profits have increased.  However, the tax cuts will be spent on dividends and share buybacks. Balance sheets are not being repaired.  In fact, borrowing is still ongoing to pay for buybacks and dividends rather than capex to lift productivity and R&D to ensure longevity of the company.

What should be of concern to most investors though are the bond vigilantes. It appears as though they are making a comeback. Investors are querying the level of debt, increasingly significant increases in borrowings and also how the U.S. Government can pay its way.

The vigilantes fret about ballooning deficits and if the target of a greater than 3% growth rate will ever be met. The vigilantes have started to fret about deficits.  It is now worth considering that interest expenditure for fiscal September rose to $459 bio or 2.4% of GDP, that’s an increase from $433 bio for 2016.

The worry is that with the tax cuts, increasing expenditures and significant increases in issuance (almost triple in 2018 from 2017),  the interest cost will balloon.  And that’s before any rate hikes and increased bond yields have been factored into the equation.

As it stands, the three-year auction went off worse than expected at 2.436%, the highest auction result since May 2007. The bid to cover was at 2.94, the lowest since November. The ten-year traded 1 bp lower than expected.  However, the bid ratio was lower than the average. The ten-year closed at 2.868%.

Recap. 

Equities: The S&P 500 fell 0.13 %. The Dow fell 0.62% and the Stoxx 600 rose 0.3%. The Vix closed at 15.78.

Currencies: The Bloomberg Dollar Spot Index fell 0.3%. The euro rose 0.3%.

Bonds: The ten-year closed around at 2.868%. The 2-year closed at 2.26% and the 30-year closed at 3.128%. The ten-year bund closed at 0.629 and the UK gilt closed at 1.49% and the OAT closed at 0.871%. The U.S. curve closed 2/10 at 60.2 bp, 2/30 at 86.3bp and the 10/30, closed at 25.9bp. The U.S. 5-year closed at 2.635.

Commodities: The WTI fell 1.1 %.

Bitcoin is trading around $8,861.

Aussie Market Today.

The Aussie equity market will be somewhat confused. The European markets were stronger whilst the U.S was weaker. The trend though will probably be to be a little weaker on the day.

The caveat,  of course,  will be how the Asian markets fare and whether the enthusiasm with Kim continues. A stumble in the Asian markets will see the Aussie equities weaker.

Bonds should hold steady today. Europe was stronger, and the U.S. bond market was a little better on the day. Today should be a day of consolidation.