The First Test

The First Test

Stocks were rather testy today. After opening stronger and trading some 60 points higher the stock market then fell almost 300 points on the day. What was interesting was that at about 3.30 the Dow was only down about 120 points and then lost a further 110 points in the last half hour. Today was the first decline of 1% for stocks since October and its worse loss since September being down 1.1%. Bonds had a strong day ringing into question the Fed speak of three rate rises for the year and the strength of the U.S. economy.

To me though the essence of this move is POLICY, policy, policy, or rather lack of policy and detail. Trump appears to have lost the initiative by first putting a lot of political capital into his what appears now failed immigration policy. His antagonism of major trading partners and allies has helped to create uncertainty for CEO’s, investors and offshore corporates in their businesses.

Trump appears to have a palace revolt on his hands. Some 45 Republican senators and Congressmen are uneasy about the removal of Obamacare even though it was a policy many were happy to piggyback to victory on. It appears the deep South which was pivotal to Trumps victory are uneasy about the removal of Obamacare with no replacements. That’s what they voted for but now it appears as if something is being taken away and they don’t want to lose what they already have.

On trade, the Trump team is not making too many runs. The EU is upset and dismantling NAFTA which is Tillerson’s job is stalling as TRex  is trying to get China to accede to Trump’s demand that China gets tough with a belligerent North Korea and that China stops manipulating their currency ( Trump’s siren call ), although that may be hard given there is little evidence that China is doing so. The U.S. is casting itself in protectionist rhetoric and China is about free trade. The outcome will be interesting.

At heart of the fall though I think is very simple. It’s a matter of policy. Markets rallied on the basis of tax reform and regulatory reform. Some of the proposed reform places the U.S. on a knife edge, but the real issue is TAX. Tax reform details were thought to have been released or due to be released shortly and this is not the case. The best guess is now in August and a delay seems likely until 2018. This means the optimism of the equity market will wane over time until it sees more detail.

Bonds however are now finding themselves in the sweet spot. After the selloff there is a clear differential in income for bonds versus equity dividends, making bonds an attractive income source. This means bonds can rally and that is what we have seen. The U.S. 10 year treasury is now trading 2.42% which has now rallied about 18 pts since this time last week. Bonds have now rallied 11 basis points in the last three sessions. The 2/30 was around 177 and 2/10 flattened to close around 115 pt.  Much will now depend on what Yellen says on the 23rd as markets digest what the Chairwoman says and the Fed’s outlook will drive market direction.The 10 year Bund was slightly weaker and closed around 0.46%.

Commodities were mixed. Crude slumped today and is now trading around $47.50. The Dollar index fell 0.3%. Copper was off 1.8% and gold fell 0.1%. Iron ore was down marginally and the AUD is locked in around 0 .7680.

Aussie Market Today.

Equities should follow the U.S. market today and trade lower over the course of the day. The U.S. 10 year versus the AUD 10 year is now around 37 points. This spread differential is looking attractive again ( even though it is well below the long term mean) so I would expect to see reasonable buying of Aussie 10 years. For many international investors Aussie bonds are attractive and I would expect to see offshore purchases around these spreads.

With iron ore steady and the U.S. rates rallying I would expect to see the AUD steady to slightly better.