Normality?

As we move to towards the last trading day of the month and recognise that a third of a year has passed, we should ponder just what we have learnt and what forecasts are now relevant. For those that have missed the last few months, what we have seen is a rally that some are now calling a melt up.

For the bond bears, most of the time it has been distinctly unpleasant. But maybe, just maybe, with growth still rumbling along and a compliant Fed that is fearful of upsetting Trump, they can shine, well perhaps.

On the day, however, what we saw was a rampant stock market rallying because there is no fear of rate hikes, tepid growth is backing generally as expected weak results and low inflation. What more could an equity bull market want? Oh yes, I forgot the momentum traders. And yes, they have started to return again as well after a period where they frankly found it easier playing in bitcoin.

Bonds were a delight today if you were a bear. From the CME open, the sellers piled in and sold. CTA’s were active sellers and some algo traders were spotted on the sale side. A large macro fund that was a buyer last week and putting on steepeners was a seller in quantity today.

Consumer spending was seen as the reason why the bond yields flipped today. U.S. consumer spending increased the most in 9 ½ years and pricing pressure remains muted. The data is now starting to put the Fed into a bind.  Powell is due to give a press conference after the Fed statement. And investors will be looking to the statement to see how the Fed is viewing the current market.

Investors will also be looking for guidance as to its activities in winding down purchases of mortgage-backed paper and whether it will boost purchases in Treasuries instead. For the moment, however, the Fed is caught in a dichotomy of sorts. Economic growth continues but inflation remains subdued. The Fed is expected to keep rates on hold at its May FOMC meeting.

Today saw the stock market climb above their record highs to start the week. Financials led stocks higher. The market is being buoyed by the better than expected economic data and the prospect that the next round of talks with China will go well. It is expected that the enforcement mechanisms could be agreed according to Mnuchin.

About 80% of the S&P 500 companies have reported their quarterly earnings and have beaten estimates. Analysts now expect earnings to have fallen just 0.2% in the first quarter which is a sharp improvement from the estimate of 2% at the beginning of the month. Volumes on the day were well down with just 5.81 bio shares changing hands versus a 20-day average of 6.56 bio.

The Rant.

We know we are in a bull market because investors are piling into risk. Banks are re-establishing CDO desks. (Remember them? They were part of the problem in 2008.) And that is being done to sate investor demand for the leveraged product. Trading volumes this year are up 40% and issuance is expected to be in excess of $100 bio this year compared to $80 bio in 2018 (JPM Research).

Citibank, Deutsche, Goldman’s Societe Generale and JPM have all been actively hiring traders and sales staff. The average return for a CDS linked investment grade tranche since 2014 has been around 8.1%. Hence, you can understand why in a low yield environment the CDO’s are attractive. In 2014, more than 50% of the index tranche trading volumes came from banks. Today, 90% of volumes are hedge funds, real-money investors and insurance companies.

Unlike in 2008, today’s regulator is coercing banks into selling all the tranches. Previously, banks held tranches, and especially the lower ranked tranches in their trading books. The trades are short dated, and this partly offsets the knowledge that once a position has been sold banks will be reluctant if not disinterested in buying back positions if the trade sours.

Market Recap.

Equities: The S&P 500 rose 0.11%. The Dow rose 0.04%.  The Vix closed at 13.11. The Stoxx Europe 600 Index rose 0.1%.

Currencies: The Bloomberg Dollar Index was flat, and the euro rose 0.3%. The pound rose 0.2% and the yen fell 0.1%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.527%. The 2-year is trading at 2.294% and the 30-year is at 2.955%. The U.S. curve closed on the day with the following closes 2/10 at 23.3 bp, 2/30 at 66.1 bp and the 10/30 closed at 42.6 bp. The U.S. 5-year closed at 2.312%. The 2/5 spread is now 1.6 bp. The ten-year bund closed at 0.002% and the British gilt closed at 1.155%. The 10-year yen gilt is trading -0.031%.

Commodities: WTI settled at $63.50 a barrel but remains under a cloud as Iranian sanctions are about to be applied shortly.  Gold fell 0.6%.

Bitcoin is trading around $5,135.

Aussie Market Today.

Equities for the moment look a little flat. I was expecting a rally previously. Offshore equities rallied in way of sorts. There is expected good news relating to trade between the U.S. and China and that should help.

Volumes in the region should remain weak as we are now in Golden Week and Japan is away until 6 May. With Asian volumes weak, this probably will be reflected with a stilted market. And then, of course, there is the looming Australian election. After the first debate, the consensus seems to be that Shorten bested his opponent and that now shortens the odds for a Labor win.

Bonds will be driven by expectations that the RBA could cut rates just ahead of the election in May. Bond investors also have to weigh up index extension which will be a little longer. The front end has the feeling that is expensive as it is priced for a rate cut. And flatteners appear to be the favourable trade as the front end is sold and the longer maturities are being bought.

The extension will be around 0.036 years and in the Barclays Index that will be 0.193 years (CBA Research). April is a maturity month with heavy maturities. Some 44% of ACGB’s have an April maturity.

I am still unwilling to believe that the RBA will cut a few days ahead of the election with steady growth and very low unemployment. The housing market which was a concern earlier in the month appears to have stabilised and if anything is again improving (anecdotally). And if that’s the case, then the argument for a rate cut looks weak.

Bonds are expected to remain steady to slightly weaker. And the trend offshore tends to vindicate that view. The underlying question will be whether a Labor Party will boost the economy. Certainly, the jury is out on that, more likely the economy will remain stuck. If that’s the case then the environment is bond friendly, low inflation low growth and weak issuance.