Whoaa.. What Now?

Friday saw the equity rally continue and bonds continued their sell-off of sorts. However, that optimism may be short-lived as the Chinese Deputy Premier has called off talks relating to tariffs after a tweet from Trump that suggested that the U.S. was not in a hurry to reach a deal with China. In fact, come 12 a.m. Washington time $200 bio of Chinese products will be subject to tariffs. A now combined $250 bio of products will be levied and this is about half the value of all Chinese goods imported in 2017. In retaliation, China will impose levies on $110 bio of U.S. goods representing about 70% of U.S. goods entering China.

What we saw Friday, however, was very different to what we will probably see today in trading. The S&P 500 Index finished a second weekly advance ending just 2 pts from an all-time high.  ETF’s saw inflows of $38 bio. The equity market has largely shrugged off the interest rate hike expected this week.

Optimism abounds. This optimism is attributed to stellar earnings.  In addition, the manufacturing purchasing manager’s index beat estimates to a decline in unemployment applications.  This suggests that the economy is still accelerating rapidly. The performance of the equity market is all due to strengthening economic fundamentals, well were – up until the weekend when we may have to think about Tariffs Again!

Up until the weekend, investors were unfazed by the prospect of a rate hike. The belief is the economy is growing sufficiently quickly such that a hike won’t have any major impact on the economy.

Whilst equities are going gangbusters, the municipality market has just suffered its fourth week of losses. The Barclay’s municipal index has lost 0.82% since the beginning of the month. The rout is tracking the sell-off in treasuries which has lost 1.12% this month to date.

Bonds are on a slightly different trajectory. The U.S. 2-year treasury remains unaffected by the noise of Europe, the U.S. and elsewhere. However, for longer maturities, the market stabilised and rallied a little way. The market has an 80% probability of a rate hike priced in for December.  This explains the merry dance that the shorter maturities are leading.

For the Fed, the current market conditions mean it has to be careful to ensure that growth continues even with unemployment at near record lows. For the Fed economists, the Fed’s optimal rate path is well above the market pricing. The Fed sees 4 increases whilst most investors only see 2. The Fed still has to contend with a flattening yield curve and that flattening commenced in 2016. The three recessions since the mid-1980’s have occurred after the unemployment rate and the Fed’s policy rate have their own inversion with the short-term interest rate higher than the jobless rate, a point that will be reached next year under current policy projections.

For the week ahead, the main thrust will be political. With Trump and the GOP under pressure, the appointment of the new Supreme Court judge Kavanaugh has taken on a serious and vital tone. Should the Democrats get up and force the non-appointment of Kavanaugh, a huge amount of uncertainty will arise. Also, remember the debt ceiling hits the ceiling later this month. Expect some argy-bargy deal to take the ceiling beyond the mid-terms.  And then and only then will the real argy-bargy begin.

And in a blast for animal rights, McDonald’s has come under pressure from the NY Pension Fund for inhumane treatment of chickens. The Pension holds about $300 mio worth of stock and is agitating for better care of battery chickens.

Market Recap.

Equities: The S&P fell 0.05%. and the Dow rose 0.32% while the Vix closed at 11.68. The Stoxx 600 Index gained 0.4%. The MSCI All-Country World Index gained 0.3%.

Currencies: The Bloomberg Dollar Index rose 0.2% and the euro fell 0.2%. The pound slumped 1.4% following Brexit news suggesting that Europe was digging in its heels around the negotiations.

Bonds: The ten-year closed around at 3.066%. The 2-year closed at 2.804% and the 30-year closed at 3.203%. The ten-year bund closed at 0.46% and the OAT closed at 0.78%. The U.S. curve closed on the day with the following closes 2/10 at 25.9 bp, 2/30 at 39.6 bp and the 10/30 closed at 13.5 bp. The U.S. 5-year closed at 2.952%.

Commodities: WTI gained 0.7%. while Gold fell 0.7% and the Bloomberg Commodity Index gained 0.6%. Gold was affected by a large sell order that hit the market early in the morning session. Some 10,000 contracts hit the market about 8.45 am and this volume represents 30 times the 100-day average for the particular time of the day.

Bitcoin is trading around $6,734.

Aussie Market Today.

Equities were solid on Friday. However, the spectre of tariffs and the impact on the Chinese economy may see equities slide in a reflection of the uncertainty. One has to watch the politics.

Bonds may benefit from risk off trades again. Political uncertainty has once again stoked tariff fears and this may result in risk off. Expect some volatility.

The Aussie dollar improves as the tone for commodities improved. The Aussie appears to be on a roll and that could last for a while yet as China is looking to keep its economy growing.

Geopolitical risks remain high.