Sir John Templeton once mused, bull markets are borne out of pessimism, grown out of scepticism, mature on optimism and die on euphoria. Just where are we now?
On a fairly lacklustre day, one could be forgiven if they had slept for the most part and awoke in the final hour because that’s when most of the action occurred. The day started off so well. Shanghai-listed shares rose 1%, the Hang Seng was up 1.15% and Asia was happy. Europe followed suit with a little optimism and earlier comments by Powell suggesting that inflation should remain low assisted the positive tone. The bulk of the losses in the equity market happened in the final twenty minutes or so.
So what was the shot that was fired? The trigger was Powell saying that the Fed could raise rates past the neutral level. Powell elaborated on his concerns relating to fiscal policy and the sustainability of the current fiscal policy. This allowed the hawks to come out to play. The comments and interest rate hikes dismayed Trump who vented in his usual manner. Banks and financial stocks were hit following the release by the Fed.
On a day when the Fed was expected to hike (first time that the Fed has tightened in September during a tightening cycle), Europe saw a little covering of shorts in the bonds. The bunds rallied and so too many of the majors. The BTP / bund 10-year broke 229 and the bund curve flattened slightly. Of news is that one of Merkel’s key backers has a lost a vote for the head of the parliamentary party. This further undermines her support in the grand coalition moving forward.
In the U.S., Powell’s comments sparked a rally in the bond market. Interest rate futures traders have stuck with their bets that the Fed will raise rates once more this year and two times next year. Currently, the futures market is implying a 79% chance in December. The expectation is that the Fed will have rates in a target range of 2.25% to 2.5% in December. The Fed sees interest rates at 3.1% at the end of 2019. As a result of the day’s commentary, the bond curve flattened.
The Fed itself sees one more hike in December and three in 2019, with one more in 2020. These moves would put the benchmark at 3.4%, and then projected to stay level until 2021. The Fed’s projections have the economy growing at a steady pace through 2019. GDP is seen as growing by 2.5% in 2019, and 2% in 2020. There is no discussion around the growing deficit nor global tariff increases. Inflation is expected to remain steady at around 2% and unemployment to fall to 3.5%.
Investors are starting to pull cash out of HY ETF’s and invest in bond ETF’s as protection against an equity market that could possibly sour and rising trade tensions between the U.S. and China. The classic risk-off trades are becoming more prevalent as the equity market pushes ahead. Over the month, some $2.4 bio in the iShares iBoxx High Yield Corporate ETF have been sold. If the trend continues, then this month will be a record for outflows. Since 2013 average fund flows for high yield ETF’s were 88% lower in months when the 10-years traded higher. High yield is often linked to the performance of the broader economy and if the selloff continues it may well be signaling to the equity market that the economy is slowing and a recorrection is a distinct possibility.
The EU, China , and Russia are appearing to defy the Trump Administration and continue to trade oil with Iran. For Europe, it’s a matter of independence and a point of sovereignty. The EU is looking to establish a legal entity to facilitate legitimate financial transactions with Iran. The SPV will facilitate payments and trade and avoid the nasties of having to deal with the DOJ or being caught up in a U.S. investigation.
The EU wants to see a stronger and more relevant euro. And such lofty ambitions may well begin with trade between Europe and Iran but also between China, Europe and Iran. The bloc using the euro has the advantage of allowing the EU economy and businesses to grow independently of the U.S. $ and U.S. economy without interference. But what happens if Trump follows through with his threat of not doing business with those who wish to trade with Iran?
German maritime shippers have long been a powerhouse in the shipping industry and ably supported by both the banks and KG’s ( lenders specifically to commercial shipping). That has now all ended and the shipping industry in Germany is in disarray after the major banks have withdrawn amidst heavy losses and a number of KG’s have gone out of business. The German banks have been left with tens of billions of non-performing loans, some $100 bio in toxic debt and sales of commercial vessels at a 70% discount. Before 2008, Germany accounted for 26% of new ship orders, now it barely accounts for 2.3%.
In other news, Ford said that tariffs could add an additional $1bio of costs.
And in a twist which has since been denied apparently, the Deutsche Bank Board went through some scenarios of buying Commerzbank or UBS. It appears as though the most favoured scenario was buying UBS as there were strong synergies that could be gained as each bring different expertise.
Equities: The S&P fell 0.3%. The Dow fell 0.3%. The Vix closed 12.2. The Stoxx 600 Index gained 0.3%.
Currencies: The Bloomberg Dollar Index was unchanged. The pound fell 0.1%.
Bonds: The ten-year closed around at 3.048%. The 2-year closed at 2.819% and the 30-year closed at 3.182%. A slight flattening today. The ten-year bund closed at 0.534% and the OAT closed at 0.849% (a level seen in January earlier this year). The U.S. curve closed on the day with the following closes 2/10 at 22.9 bp, 2/30 at 36.2 bp and the 10/30 closed at 13.1 bp. The U.S. 5-year closed at 2.944%.
Commodities: WTI fell 1%. Gold fell 0.5% and copper slipped 0.2%.
Bitcoin is trading around $6,499.
Aussie Market Today.
Equities probably slide on the day. However, the key to the day’s trading will be the Asian markets. A strong rally in Asia will see the ASX rally.
Bonds saw a little bit of short covering and now that the FOMC is out of the way and with an expectation that rates will be hiked again in December. The Aussie bond market in the meantime is likely to trade according to the data.
The overnight trends are somewhat confusing given little movement. However, the expectation is that rates and bond yields could slowly climb. If GDP or inflation numbers come out on the low side expect a rally. U.S. GDP for the moment looks like it could exceed expectations and that would mean a stronger equity market and higher bond yields. It’s all down to the data.
The Aussie dollar will once again be beholden to views on commodities. China holds the key.
Geopolitical risks remain high.