On a day when the equity market should have been leading a merry dance up celebrating the sheer luck of oil stocks, the market weakened. Technology was the culprit. And much of the fall has to do with the possibility of the FAANGS and other technology stocks lacking immunity in the trade standoff between China and the U.S.
In China, the big fall in the equity market is also aligned to falls in Chinese technology stocks. The Chinese technology-focused index has fallen some 7% over this recent selloff. China’s Shenzen blue stock index fell 2%. Chinese equities are now 20% lower since January and are 45% lower than in 2015.
Elsewhere, pain is being felt. The shift in the global trading order is being felt between yuan and dollars where the curve is now inverted. The one-month implied volatility of the U.S. dollar relative to the yuan is now at a premium. The high short-term FX volatility is making it difficult for international fund managers to hedge positions.
The volatility curves are also inverted between Canada and the U.S. and Mexico and the U.S. The higher volatility and the inversion of curves mean portfolio managers will be more likely to take less risk abroad and remain in their respective domestic markets.
For the moment, the equity market is trading on Trump’s tweets, Kudlow’s statements and Mnuchin’s musings. And that probably is not a great way to trade. Every time the trade stance softens, the equity market rallies. And every time there is some ruckus, the equity market sells off. Meanwhile, the Atlanta Fed Governor Raphael Bostic is warning of the increased risks to the economy should a trade war start.
Crude is rallying hard as the U.S. supplies have fallen. Given the Trump administrations tough stance with Iran over oil, it appears as oil production cannot be increased to cover the expected shortfall.
An issue that is causing the Fed problems is the overnight interest rate. And it’s a problem not only for the Fed but also other central banks. The narrowing gap between Fed Funds and the interest on excess reserves is starting to limit the Fed’s ability to hike rates. This suggests that the Fed is closer to the balance sheet bottom than they thought.
The reduction in the balance sheet is making it more expensive for banks to borrow excess reserves to meet obligatory regulatory requirements. The spread between the effective Fed funds and IOER is a mere 3 bp. Whilst excess reserves appear ample, one has to remember that 90% of those reserves are held by 5 % of banks.
If the banks have to borrow more in the way of excess reserves, more money will be borrowed from the Fed funds market, creating a demand for reserves and forcing cash higher. The impact is that interbank borrowing costs will remain high and this has the potential to disrupt broader economic activity through higher borrowing costs.
Equities: The S&P fell 0.86% and the Dow fell 0.69% while the Stoxx 600 rose 0.7%.
Currencies: The Bloomberg Dollar Index rose 0.6% while the euro fell 0.8%.
Bonds: The ten-year closed around at 2.827%. The 2-year closed at 2.508% and the 30-year closed at 2.969%. The ten-year bund closed at 0.324% and the UK gilt closed at 1.25% and the OAT closed at 0.659%.
The U.S. curve closed the day with the following closes 2/10 at 31.8bp, 2/30 at 45.90 bp and the 10/30 closed at 14.0 bp. The U.S. 5-year closed at 2.699%. The U.S. yield curve flattened on the day.
Commodities: WTI rose 1.5% while gold fell 0.2% and copper fell 0.6%
Bitcoin is trading around $6,117.
Aussie Market Today.
The Aussie should be steady. Today appears to be a risk-off day. However, watch for comments as the mood could change rapidly. Its all about trade and the potential damage to supply chains.
Moreover, geopolitical risks remain high.