WHERE ARE THE HAWKS?

It was not so long ago when the mere mention of deficits don’t matter would send conservative politicians and central bankers  into an apocalyptic rage. It would appear that the conservatives have largely forgotten that mantra when it comes to the Trump presidency. Currently, the debt ceiling of $21 tr is about to be breached again.

The $1.5tr of tax cuts look likely to increase the deficit to $1 tr next year and in this quarter will see $ 441 bio of issuance the most for about 8 years. Eight years,  the times were very different. It appears as though the hawks have flown off and taken the chickens with them.

Where is the rage? Why has the mantra of reducing deficits suddenly been forgotten? This is not a U.S. phenomenon but one that most conservative Governments have largely forgotten now that they are in Government, Australia included.

Markets are now starting to have a think about just what is happening. Trump and Mnuchin have heralded between 3% and 5% growth. Markets have largely taken those assertions at face value. Certainly, the market spruikers have and so too the TV business analysts.

But what we don’t know is what supports this hypothesis as the tax cuts only came late December. There is little or no evidence to support the proposition, either anecdotally or otherwise. The economy was already growing at around 2.5% or so under Obama and did not suddenly stop when Trump became President. Not a lot so far has changed except the deficit keeps ballooning and that will become a bond market concern at some point. In fact, given the extreme weather in the U.S. during the last quarter, there is a chance that the economy slowed a little.

Spending looks likely to continue. The Infrastructure Bill wants about $200 bio to finance a number of projects including the wall and an investment of $1.6 tr from the private sector. Such investments will not come without a cost as tax abatements will be required and so too some form of rent. Returns will be required. This means further reductions in taxes collected and a ballooning in the deficit.

Markets generally are becoming weary. The ten-year bond is now offering a better return than the dividends of the S&P 500. High yield spreads have tightened significantly and offer little margin for error. Spreads have tightened as equities have rallied. But this is likely to change over the coming months if the concern about inflation increases.

Inflation and an expectation that economies are growing have led to the current selloff in bonds globally. As central banks step away from the policies that brought us negative interest rates, bonds are likely to rise. As asset purchases by central banks slow, then so too will the rally. For the moment a sector rotation does not appear to be in play. Mutual funds, for example, are still around 55% invested in equities (Lipper) and only 2% lower from 2014 numbers.

For market watchers, we are in for some interesting times. Inflation is the key and weak inflation was why the Eurozone did not continue with its sell off today. German inflation was 1.4% and that caused sellers of bonds to slow the selling.

For the moment inflation remains under control. However, what happens in a trade war which Trump appears to want to have? Inflation and deficits will in time cause central bankers to become nervous and a misstep in policy could signal a rout. Trump will present his State of the Union address and is expected to focus on his tax cuts and how well the economy has done since he came to power. His tax cut win may end up being a Pyrrhic victory as the mid terms loom November and the Democrats want nothing to do with this administration and as such every legislative victory will be hard fought.

 

Recap: 

Equities: The S&P 500 fell 1.1%. The Dow fell 1.4%. The Stoxx 600 fell 0.9%.

Currencies: The pound rose0.5%, the euro rose 0.1%, the Bloomberg Dollar Spot Index was steady.

Bonds: The ten-year hit 2.725%. The 2-year closed at 2.12%.the ten-year bund closed at 0.624% and the UK gilt closed at 1.46% and the OAT closed at 0.963%. The U.S. curve closed 2/10 at 59.7bp, 2/30 at 85 bp and the 10/30, edged flatter to close at 25.1.

Commodities: Gold fell 0.3% and WTI fell 1.2 % on continuing inventory build-up in refinery capacity in the U.S. Zinc rose on supply fears and hit a 101/2 year high.

Aussie Market Today.

Bonds look set to be slightly bearish but could stage a little rally today as equities should be weak on the day. The lead from overseas is bearish and that will influence today’s trading. For some, this will be an opportunity to buy into dips.