How much further will Treasuries fall and what does this say about not only the U.S. economy but also the global economy? Generally, a low long rate means the prospects for the economy are muted and if output slows then stocks slow, or so the theory goes.
Since the scare on Friday when the 3-month bills and 10-years inverted, the markets have been awash with concern over growth. The spread is now around -5 bp. Risk assets are being switched for less risky assets and valuations are under pressure. The 10-year is closing on 2.4% fast and stocks are holding steady as information is being slowly digested. The markets are not just fearful yet, but fear appears to be building.
The Chicago Fed’s National Activity Index continues to remain soft. The February reading slipped from -0.25 in January to -0.28 in February. It is worth remembering that since March 4, U.S. 10-year treasury’s have rallied some 35 bp. Expect some profit taking from time to time.
There was some very large selling in the pits today with a large fund selling a large chunk possibly making room for supply later this week. The selling order halted the rally in 10’s at the time and that was followed by a nice chunk from a hedge fund.
The major sale in the 10’s had a chunky $1.045 mio dv01 with the larger sale accounting for $660k mio dv01 and the block of 5k accounting for $385k dv01. (DV01 is the change in price in dollars. It gives the dollar variation in the bond’s value per unit change in the yield. In this case, for every basis point movement in yield there is a risk of $1.045 mio)
Many bond investors are now pointing towards a rate cut by the Fed. The CME certainly has a rate cut firmly in mind with only a 40% chance of rates on hold for 2019 and an 87% chance of a cut by January 2020. Investors are looking for a deep cut and the Fed is one of only a few that can cut rates.
Technology stocks were weaker on the day whilst consumer stocks and industrials led the gains. Apple fell 1.2% on the day and stock traders are now concerned that interest rates are falling because the economy is slowing and that’s not good for equities.
European shares slumped even though German business morale remains buoyant. The IFO economic institute release had the business climate index rise to 99.6 up from 98.7.
Uncertainty is building. And why wouldn’t it? Brexit is now lurching towards a disaster as May acknowledges such. May lacks support in Parliament for her Brexit deal and she continues to try and garner support for her Bill. Meanwhile, on the streets, demonstrators are protesting about not leaving the EU. It’s a little bit like a Greek tragedy. It’s hard trying to work out just who is the baddie and who is the good guy at present.
Inversion remains the word. What investors have to decide is if the inversion in the yield curve between 3-month bills and 10-year notes is structural as a result of treasury’s activities or if it is the indicator of recession.
For those interested, since the end of Bretton Woods era, an inversion of this type has been followed by recession. The odd exception was the Long -Term Capital meltdown of 1998. The economy did not invert until 2001. For the moment, we don’t have a clear an unambiguous signal, and perhaps we will have to wait. Unlike in 1998 credit is still available and the bond market remains liquid. At this time, the Fed does not anticipate any major economic weakness.
For the data fiends out there, the issue with applying this type of theory as an indicator of recessions is well somewhat witch-doctorish. Because recessions are relatively rare, the data is not robust and statistically irrelevant. But that does not stop us comparing the data to other points in time and finding a correlation of sorts.
However, not all is lost in the attempts to predict recessions. Sustained yield curve inversions are virtually perfect as a recession indicator. The reason is simply the bond market functions an efficient aggregator of evidence pointing to a recession. The volume of opinion is what drives a bond market’s ability to pick recessions.
If a recession were to appear, markets tend to discount a little in advance. Every U.S. recession in recent times has started with the S&P 500 Index falling.
And in a win for the West and a sign that China is paying attention to property rights, Jaguar Land Rover Automotive Plc had a rare win in a Chinese Court. Jiangling Motors the manufacturer of the Landwind X7 was ordered to stop making the vehicle as it found that Jiangling had copied at least 5 unique features form the Evoque. This is the first such case where a foreign company has won a judgement in its favour. Honda and Porsche have long complained of knock-off models being built by Chinese rivals.
And now that the Mueller investigation has finished, Mr. Trump can now release his inner self. Trump has already vowed to investigate those who investigated him. The report at this stage has yet to be released. But of more importance is the slump in both the Chinese and U.S. economies following his imposition of tariffs. Lipton ( IMF First Deputy Managing Director ) said, “U.S.- China trade tensions pose the largest risk to global stability”.
Equities: The S&P 500 fell 0.08% while the Dow barely rose, up 0.06% The Vix closed at 16.33 while the Stoxx Europe 600 Index was down 0.5%.
Currencies: The Bloomberg Dollar index fell 0.1% while the euro rose 0.1% and the pound fell 0.1%. Sterling traders have been actively seeking protection.
Bonds: (as at 4.30pm). The ten-year is trading at 2.404%. The 2-year is trading at 2.25% and the 30-year is at 2.866%. The U.S. curve closed on the day with the following closes 2/10 at 15.2bp, 2/30 at 61.3bp and the 10/30 closed at 46.1bp. The U.S. 5-year closed at 2.185%. The 2/5 spread is now -6.7bp. The ten-year bund closed at -0.031% and the British gilt closed at 0.981%. The 10-year yen gilt is trading -0.082%.
Commodities: WTI rose 0.2% and gold rose 0.8%.
Bitcoin is trading at around $3,888.
Aussie Market Today.
On the day, I expect some recovery in stocks. The sell-off slowed last night. However, the trend remains risk off. The success of the market will be dependent on whether Asia bucks the trend and rallies. Commodities were slightly better on the day and bonds were slightly stronger. Stocks can recover a little.
It’s all about bonds at present. Last night saw the rally continue a little further and this trend looks to be intact for a while. With the Australian economy appearing to slow, investors will look towards the data to plot the next moves. Expect the Aussie bonds to continue to rally and expect demand for credit to also continue.