Run Away, Run Away.

That’s pretty much what happened today. Equities plunged, falling the most since June and volatility is clawing its way back to the long-term mean. The rout in treasuries has forced some repricing of risk assets and that’s what we saw today. Nine of the 11 main sectors were sold and high yield dividend stocks fell after the 10-year pushed through 3.2%.

As the bond rout continues, emerging market shares shed the most since February, European bonds retreated and commodities tumbled.

Finally, the steady withdrawal of liquidity by at least one central bank, a strong U.S. economy, and a Fed which may be a little behind the curve is causing some uneasiness in markets. The ECB cut its monthly purchases in half this month. The strong data in the U.S. suggests that there will be a few more rate hikes and those hikes are not necessarily in the valuation models. What we are likely to see is some repricing and we are starting to see some now. And the great unwind is only just beginning.

For the here and now, Friday’s data looms large. Payrolls and average weekly earnings are suddenly gaining more interest. Any increase in wages especially if it’s a meaningful increase will test the bond markets resolve. Inflation fears are rising and as those rise so too will bond yields. However, we could see a bit of retracement if the numbers come lower than expected. The bond market, in particular, appears to be poised on a knife edge.  This does not mean there were not buyers of bonds today. By all accounts, a significant bond fund continued to buy the long end and this helped to stabilise the rise in yields to some extent. There were also the usual dip buyers out of Japan.

Europe on the day followed on from Wednesday’s carnage in the treasury market. Bunds (German bonds) blew out and so too the gilts (UK bonds). Ten-year benchmark bond in gilts moved 10 bp to close around 1.67% and bunds moved 6 bp. Part of the selloff is linked to the Fed hiking rates. If the Fed continues to raise rates,  it becomes easier for the ECB to also hike rates.

For some, it is not all bad news. For those high yield companies looking to borrow or refinance debt now is a good time. High yield spreads are now at about T+316 (ICE BAML). Like all things in this market, a lot depends on the company. Higher quality firms appear to be deleveraging as low-interest rates have helped boost interest coverage. This is technical and can quickly change. There are some concerns about the amount of leverage being carried because add backs and low-interest rates are making the leverage look a little lower than it actually is and with time this could be troublesome.

For those looking for signals, the tight spreads may be indicating the beginning of the end of the current market.  Junk bonds have yielded a good return for years and the party may be just about to come to an end. A bottom in spreads precedes recessions.  A low of 2.41 was recorded in July 2007. However, the spread between high yield bond spreads and the ISM surveys are negatively correlated so that when the economy is weak spreads are wide. The spread continues to tighten and this indicates that the economy still has legs.

And then we add another dimension, the trade spat between the U.S. and China, and this is only going to get more testy. Vice President Pence launched a tirade against China in a speech today. Pence outlined China’s involvement in hacking and trying to sway political unease and political interference. These allegations will do little to ease the tensions between the two nations.

In fact, within China there appears to be an increasing consensus that the ongoing tensions between the U.S. and China are not going to be a short-term issue, rather tensions could escalate further. Apple Inc and Amazon both denied that their systems had been infiltrated by malicious computer chips inserted by the Chinese military. However, following on from Pence’s speech today, this only raises tensions.

And the Republicans aim to confirm Kavanaugh this weekend after the FBI report was completed. The FBI did not interview either party and was closely monitored by the White House.

Market Recap.

Equities: The S&P fell 0.82%. and the Dow fell 0.75% while the Stoxx lost 1.1%. The Vix closed 14.22.

Currencies: The Bloomberg Dollar Index gained 0.1% while the euro rose 0.3% and the yen climbed 0.6%.

Bonds: The ten-year closed around at 3.19%. The 2-year closed at 2.872% and the 30-year closed at 3.348%. The ten-year bund closed at 0.536% and the OAT closed at 0.879%. The U.S. curve closed on the day with the following closes 2/10 at 31.5 bp, 2/30 at 47.6 bp and the 10/30 closed at 15.9 bp. The U.S. 5-year closed at 3.047%.

Italian 10-years closed at 3.337%.

Commodities: WTI fell 2.5%. Gold was flat while silver was down 0.34% and copper is back on the slippery slope and is down 1.7%.

Bitcoin is trading around $6,546.

Aussie Market Today.

The trend is that equities should get sold. With the weekend just around the corner, investors may seek to reduce risk and sell their longs. The odds are that the data tonight in the U.S. could be strong and that means bonds rise in yield. How far those yields rise will determine how the equity market fares. On balance, better to be square or not too long and that points more to selling.  Also given the recent news, it is hard to envisage the Asian markets performing on the day.

Bonds are likely to follow the trend in the U.S. and weaken a little. The real reaction for bonds will come after the jobs report and wages report are released and the Aussie market will be closed bar the futures market. On balance, the risk of a weak number is less than a strong number so traders may err on the short side. I expect Asia to be a little weaker on the day and Asian trading will drive trading levels here.

On an interest differential basis and weak commodity prices, there does not look like much respite for the Aussie short of intervention by the RBA. I expect the weakness in the Aussie to continue.

Geopolitical risks remain high.