Something In The Air.

There is something in the air at present and it reeks of tensions. The tensions are numerous and when aggregated sum to something meaningful for markets to ponder. Tensions exploded and Trump was in the thick of it. Trade tensions with China increased and tensions with Iran ratcheted up several notches after the Iranians took over a British oil tanker. There was some commentary that the tanker was receiving false GPS reads courtesy of signals sent by Russian beacons in the area and thus strayed into Iranian territorial waters. (At least that is what MI6 is postulating). Clearly the taking of the British tanker is upping the stakes and that led to a market reaction with some selling of risk.

The broader market concerns over the latest action by Iran are the restriction of the flow of oil and goods. Any restriction in a global economy which is already under pressure from tariffs would be yet another negative for the global economy.

The equity market slipped on rising geopolitical tensions and the possibility that the Fed may only cut by 25bp. Earlier in the day the market was stronger with Microsoft reporting strong results however the S&P 500 Technology Index fell 0.55% on the day. Second quarter profits of the S&P 500 companies are now expected to be up 1%. Friday was also an option day, so some chop was expected. Interestingly and good news for stocks in general another major railroad operator posted a better than expected quarterly profit. That’s good news for the economy in general. The Dow Jones Transport Index was up 0.6%. Trading volumes for Friday were slightly less than average with 6.25 bio shares being exchanged versus a 20-day moving average of 6.69 bio shares.

Interestingly bond traders moved away from bets that the Fed would slash rates by 50bp. This was possibly in response to comments from one of the more dovish FOMC members James Bullard who suggested that a cut of 25 bp was all that was needed at this time. Interest rate traders now have a 24% chance of a 50bp cut and a 76% chance of a 25bp later this month. Trump once again has attacked the Fed complaining about the crazy quantitative tightening.

It is worth mentioning at this point that the Fed has become seriously spooked by Trump’s efforts to pack the Fed with people who will toe his line. Apparently insiders are quite concerned and are fearful that partisan politics could prevail in the closed door meetings on monetary policy. The Fed’s staff are concerned that Trump’s picks are there to undermine the institution in the same way that Trump appointees have purged and watered down the Environmental Protection Agency, and the Consumer Financial Protection Bureau. The problem for Trump moving forward could be that the FOMC will not wish to be seen to caving into Trump’s demands and any pressure could be counterproductive.

Weather had a major impact on the sale of soybeans. Brazil recently had to cancel a shipment of soybeans to China after the protein content in the beans fell. Drought has a affected the crop and the protein content.

U.S. energy firms reduced the number of operating oil rigs again this week. This is the third consecutive week where the rig count has decreased.

The Rant.

The issue for markets now is what the Fed is going to do over the rest of the year and in 2020. For investors they have seen the Fed deviate from a view that at least 3 rate hikes would be supported this year to at least 2 rate cuts are needed. The concern is that because the view has changed radically, will the Fed continue to bend to the market’s will, or will it stand up against the market. Either path could lead to rapid changes in asset prices.

There is nothing wrong with policy makers factoring in a change in financial conditions however if the communication goes awry then investors views can change radically.

Moving forward questions linger. Should stocks fall after the rate cut everyone expects or will there be an expectation that the Fed will cut again and hence the markets rally.

Meanwhile corporate leverage is increasing and its not necessarily going towards capex, and the yield premium is shrinking. This comes at a time when asset prices are already massively inflated. A rate cut simply adds a little more fuel to the fire.

Investors in treasuries have to decide if any money can be made with the current level of interest rates and bond yields. There is not much money to be made if you don’t believe that a recession is around the corner and the Fed is going to embark on a full easing cycle.
Times are interesting indeed.

Market Recap.

Equities: The S&P 500 fell 0.62% The Dow fell 0.25%. The Vix closed at 14.45. The Stoxx Europe 600 Index rose 0.1%.

Currencies: The euro fell 0.5%. The Bloomberg Dollar Spot Index rose 0.4%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.057%. The 2-year is trading at 1.824% and the 30-year is at 2.581%. The U.S. curve closed on the day with the following closes 2/10 at 23.3 bp, 2/30 at 75.7 bp and the 10/30 closed at 52.2 bp. The U.S. 5-year closed at 1.816%. The 2/5 spread is now -0.9 bp. The ten-year bund closed at -0.369% and the British gilt closed at 0.731%. The 10-year yen gilt is trading -0.135%.

Commodities: WTI rose to $55.63 a barrel.

Bitcoin is trading around $10,548.

Aussie Market Today.

Stocks should be steady on the day with perhaps a hint of a rally. Geopolitical risk will play its part. I expect that the equity market could rally on the day.
Bonds look a little mixed. The market will look towards data and any escalation in geopolitical risk could see risk being taken off and bonds rally.
The bid tone in credit remains. Demand continues for corporate bonds and especially so in non-bank credits.

Geopolitical risks remain high and still need to be monitored.