To Curve Or Not To Curve?

Markets must be getting tired and thin when the most important piece of financial news is about the yield curve and it appears as though everyone is weighing in, bar Trump. The term “yield curve” spiked on Google searches at 8 a.m. and the St Louis Fed has noticed a significant pickup in searches on their website with yield curve being the number 1 searched item.

Why the interest, well that’s because over the last few days Mnuchin and Powell have been chatting about the yield curve and its importance. You see the yield curve is at its flattest since 2007 and that has a lot of analysts spooked. And, for the moment in my opinion, the flatness is not a portend of a recession rather it’s the result of ultra-loose monetary policy that has flourished as well as investors need for yield.

As the Fed winds up its activities then with less free cash and massive issuance, the curve will eventually steepen before flattening. Borrowing costs are simply low, firms are not stressing too much. However, that can change quickly if sentiment changes.

Back to the story. Mnuchin has downplayed the flattening and gave a vote of confidence in Powell by doing so. One has to remember that in all the noise the other major indicator that the Fed looks at when making up its mind about monetary policy is the equity market. And that remains strong.

Investors, however, need to have a closer look at the Mexican trade deal. It smells suspiciously of a deal done quickly. The main reason the likes of Toyota rallied so much in Asia is because as a manufacturer of cars in Mexico it is in the box seat along with other manufacturers already making stuff in Mexico. They face no competition from new entrants.

The Mexican trade deal is not that great a deal if you have no presence there. Workers face similar issues to what they faced beforehand, so nothing has changed there. This makes other trade deals with China, Canada and Europe very difficult. Canada has already placed commentary and rigidity around its dairy industry support.

So the upshot of the day was that the peso returned to reality after a stellar run on the tariff news, the equity market had a small gain and the 10-year treasury moved towards 2.90%. The yuan continued to surprise after the PBOC strengthened its daily fixing against the dollar. Equities rose in Japan. However, they slipped in China. The CSI 300 was down 0.19%.

The trade tariff spat appears to have been forgotten for the moment and the market is heading off to a long languid summer holiday. The issue for Trump is that with mid-terms rapidly approaching, he needs to get stuff done and this won’t be easy.

Any renegotiations with Canada, for example, will require House approvals i.e. the Senate and Congress have to approve, that approval could take time. China, for example, is thought to be holding back and waiting for the mid-terms to pass. Meanwhile, they are undertaking a study of Trump’s supporter base to better understand Trump’s motivations.

Corporate supply in Europe and in combination with sovereign supply was seen as the major reason for a selloff in Eurodollars and bonds. EGB supply this week is about euro 11bio whilst redemptions in September tally euro 6.005 bn.

The Richmond Fed showed stronger manufacturing services activity in August at 24. The employment index rose to 25, a record. There are no Fed speakers this week and no ABS purchase operations scheduled. The Treasury will auction $17 bio two-year floating rate notes and $31 bio in 7-year notes.

The massive short on the treasury futures continues to grow. The new record short position stands at 700,514 contracts in 10-year treasury futures and a short position of 97,333 contracts in the 2-year futures. This difference of more than 600,000 is unprecedented in the positioning data, started in 1995.

Market Recap.

Equities: The S&P rose 0.03%. The Dow rose 0.06%. The Stoxx 600 rose 0.1%. The Vix closed 12.50.

Currencies: The Bloomberg Dollar Index rose 0.2%, the yen fell 0.1%. and the euro fell 0.1%. The Mexican peso slipped 1.7% after climbing 6% pre the release of the trade deal settlement with the U.S.

Bonds: The ten-year closed around at 2.884%. The 2-year closed at 2.669% and the 30-year closed at 3.033%. The ten-year bund closed at 0.379% and the OAT closed at 0.718%. The U.S. curve closed on the day with the following closes 2/10 at 21.1 bp, 2/30 at 36.1 bp and the 10/30 closed at 14.8bp. The U.S. 5-year closed at 2.777%.

Commodities: Brent crude fell 0.3%. Gold was fell 0.7%.

Bitcoin is trading around $7090

Aussie Market Today.

The lead for the equity market will come from Asia. However, given offshore movements expect the equity market to be slightly stronger.

Bonds are likely to be sold today as it’s a risk on day. You may see some short covering but that could be short lived.