Summer days.

What a day, or rather what happened today? It would appear not terribly much, although the debate in the markets has swung into let’s forget about Trump and his war with China and let’s think about inflation.

Inflation is low and borrowing costs are well a little high by comparison although in an outright sense still very low. Trump has been repeatedly pointing this out in his tweets as he pressures the Fed to ease.

Stock traders are still a little gun shy from May and it appears as though Trump has not joined the dots. Those dots being that trade or rather the threats of increased tariffs is what has caused stocks to weaken and bonds to rally. As it stands Trump is now stating that if President Xi does not meet with him at the G20, Trump will impose further tariffs.

So, what we have left now is a game of dare. He who moves first loses. The market is range-bound and buyers are becoming scant. For sellers, the game is just as hard because if no one wants to buy who do you sell to? As such, we have a very tight bored and range-bound stock market and bonds are watching from the sidelines.

For the bond market there was some movement. The yield curve flattened.  An uptick in U.S. inflation and a strong three-year auction were the highlights of the day. The 3-year auction was better bid than expected. Some believed that this was due to the dearth of positive yielding bonds elsewhere. The bid to cover ratio was 2.62,  the strongest result since September 2018. The expectation for a rate-cut in July slipped slightly with the probability now at 65.2%, down from 66.8%.

For bond investors, treasuries are the safe haven and the investors have a neutral outlook. The share of investors holding government debt equal to their benchmarks is now 62%, the highest since January 7. And that’s a rise of 10% from the previous week which was 52%.

The Rant.

At present there are about $1.3 tr of leveraged loans and most of these loans comprise those firms with weak finances. To make matters more interesting, these loans are being bundled up into CLO’s to provide even more leverage and even higher returns for yield hungry investors.

And that’s the problem. It’s estimated that about 85% of these loans and CLO’s are held by non-banks. There is a mounting concern that regulators and central banks do not have the tools to address a fallout should a situation arise.

And even more worrying is that if the malaise spread to the banking sector,  the central banks would be ill prepared. One has to remember too, that many of these businesses that are using leveraged loans employ many people and in a downturn these employees could face severe financial stress.

The leveraged market that offers returns of 9% on the loans has now doubled since 2012. This market is also of the central banks own making, fuelled by low rates, little regulation, and the emergence of shadow lenders.

In the U.S. the growth was accelerated after the Trump administration removed the financial watchdogs and encouraged the dialling up of risk by easing guidelines limiting lending to deeply indebted companies.

Corporate indebtedness is growing. It is estimated that U.S. companies have 7.7times more debt than they generate in annual earnings. (Covenant Review) Four years ago debt/ebitda was 5.5 times. Europe is not too far behind as well.

The problem for all is that as leverage increases then the stakes rise. If the central banks don’t know who owns the loans, then they don’t know how resilient the market will be in a downturn. Assuredly banks are a lot better. However, that does not mean the investors can cope with large losses. Those debt investors may not be so resilient as a bank in a crisis, but the contagion could spread. A loss of investor confidence could be far more worrying. And if anyone has seen how quickly a run on a bank can happen then you know how quickly a market can collapse.

Market Recap.

Equities: The S&P 500 fell 0.03%. The Dow fell 0.02%.  The Vix closed at 15.99. The Stoxx Europe 600 Index rose 0.7%.

Currencies: The Bloomberg Dollar Index was flat. The yuan rose 0.3%, the largest increase in 8-weeks.

Bonds: (as at 4.30pm). The ten-year is trading at 2.145%. The 2-year is trading at 1.93% and the 30-year is at 2.618%. The U.S. curve closed on the day with the following closes 2/10 at 21.3 bp, 2/30 at 68.7 bp and the 10/30 closed at 47.2 bp. The U.S. 5-year closed at 1.915%. The 2/5 spread is now -1.6 bp. The ten-year bund closed at -0.233% and the British gilt closed at 0.853%. The 10-year yen gilt is trading -0.11%.

Commodities: Crude rose 0.1%. Gold fell 0.1%.

Bitcoin is trading around $7,933.

Aussie Market Today.

Stocks will drift over the day. With little in the way of news or direction, stocks will most likely ease a little.

Markets are currently thin and directionless.

Bonds were a little weaker overnight in the U.S. but slightly stronger elsewhere. The trend probably will be to rally a little more. The future direction will be dictated by economic data and for Australia there is an expectation that the data is more likely to be weaker.

Credit looks to be well bid offshore and we may well see that flow through here in Australia.

On the day, I expect credit to be better bid and especially so in the shorter maturities.