Strange Days Ahead.

It appears as though we are done and dusted with Turkey. Until at least the next round. Turkish assets improved a little, the world sighed a relief and those European Banks (Spain, France and Italy) that were exposed to $140 bio of Turkish debt breathed a huge sigh of relief. And risk, once again, trickled onto balance sheets.

However, U.S. debt still reigns supreme despite some structural flaws, and one of those flaws may require some rethinking of actions by the Fed in the next few months. The problem is that the U.S. Treasury market is transitioning from one which is with reserves in excess to one where collateral is in excess. How can the Fed hold rates steady when, on the one hand, the Treasury is pumping out T-bills and short treasuries as it tries to fund the budget gap left by the tax cuts and falling tax receipts and a slower than projected GDP growth?

Within the Fed’s toolkit there are two options. Halt balance sheet reduction as the Fed may need assets to maintain a particular cash rate or activate an overnight facility that allows repurchase agreements. Given the weight of expected and necessary issuance the Fed is now caught in a dilemma of what to do next. To hold the cash rate steady, the Fed has been lowering its rate on excess reserves but this action won’t hold rates over a longer time frame. It works now but, may not in years’ time.

The tsunami of T-bills has created an excess in collateral in the repo market. According to Pozsar (ex-Treasury and CS Group Analyst), “the lack of use of the Fed’s overnight reverse repurchase facility tells us that every penny of bank reserves is bid and that balance sheet taper (by the Fed) from here will cut right into the systems liquidity bone.”

Either way the taper looks dusted unless the Fed can come up with alternative strategy to continue its taper. Selling of more coupon bearing securities to buy short T bills is one strategy, cut the rate on its foreign reverse repo is another either way we are in for interesting times.

As angst over Turkey abated, the treasury market lost its allure and treasuries drifted higher in yield. The good news for a number of economies though is improved growth. The German economy looks to be picking up, recording GDP growth up 0.5% for the quarter and inflation also appears to be picking up at around 2.1% annual. This is the third month in a row where the German inflation is higher than the ECB target.

Meanwhile, the Chinese government is looking to rev up the economy with a major spending plan as the economy slows and with investment growth at a record low. (Fixed asset investment grew 3% yoy, Industrial Production rose 6%, forecast 6.3%.)

The S&P Index rose to record the first up day for 5 days. The big winner on the day were the small-caps. The euro fell to its lowest against the dollar since 2017 and the Stoxx 600 fell after data showed the region’s economy was growing faster than expected.

Elsewhere, oil fell as focus returned to short term supply and bitcoin slid below $6000 for a short time.

Cryptocurrencies still appear to be on the nose.

Market Recap.

Equities: The S&P rose 0.64%, the Dow rose 0.45% while the Stoxx 600 fell 0.5%. Vix closed 14.78.

Currencies: The Bloomberg Dollar Index rose 0.1% and the euro fell 0.6%. The pound fell 0.5% and the yen fell 0.5%. The yen carry trade appears to be coming back into vogue.

Bonds: The ten-year closed around at 2.90%. The 2-year closed at 2.64% and the 30-year closed at 3.067%. The ten-year bund closed at 0.33% and the UK gilt closed at 1.26% and the OAT closed at 0.685%. The U.S. curve closed the day with the following closes 2/10 at 25.8 bp, 2/30 at 42.7 bp and the 10/30 closed at 16.8 bp. The U.S. 5-year closed at 2.774%.

Commodities: WTI rose rose 0.1% and gold rose 0.1%. The Bloomberg Commodity Index rose 0.3%.

Bitcoin is trading around $6,075

Aussie Market Today.

Equity markets look likely for a rebound if the Asian session can hold. Equities should benefit from risk on trades. The bonds will be directed by flows and also if the equity market can rally.

Bonds are likely to sell as the outlook for equities improves on the day. Nerves will be a little frayed. However, I don’t expect market volatility to ease anytime soon or rapidly. There is simply too much geopolitical noise.

The Aussie dollar looks to be under pressure. However, the relief valve remains in the form of bond rates.

Geopolitical risks remain high.