Which Fork to Take?

Markets were relatively well behaved and that’s the problem.

Friday was interesting from the simple perspective that a lot happened but nothing happened. Markets were relatively well behaved and that’s the problem. Whether the algos, that run trading systems, don’t have geopolitical risk or political risk as risk factors are only part of the story. But Friday was a funny day.

A quick recap. Mueller has been able to get to and talk with many key Trump associates and managers and they all appear to be singing from the same hymn book.

Given that some must have critical information probably explains Trump’s bizarre missive on Fox “how can they impeach the President if he is doing a great job, they can’t can they”. And then we had Lindsay Graham saying there was no need to impeach Trump because the constituency did not wish to do so.

And in the process citing the Clinton/Lewinsky affair. The big difference being that Clinton lied about an affair. However, Trump has a lot of question marks hanging over him.

The real question is, though, why the equity market rallied. That appears to be partly because earnings growth is still solid and Mexico and the U.S. are close to a trade agreement. This paves the way for Canada to return to talks relating to trade with the U.S.

Otherwise, the day may well have been risk off. Powell suggested that the economy was in good shape and that in all probability the Fed will tighten next month and inflation is in the target range of 2%.

The other commentary from Fed officials was that they would not be influenced by Trump. For equities, Friday was a momentous day and marked another milestone, a bull run lasting nine-years.

The other news that came out of Powell’s somewhat dovish commentary was the weak dollar. For bonds, it was a fun day. Swaps played the spread game flip flopping between steepeners and flatteners but compared the bonds the volume was light.

Bonds were in a league of their own device. After initially selling ahead of Powell, bonds roared back on the CME open. Real money, short coverers, algos, everyone was there for the party. The shorts were forced to cover and the real money accounts rushed in to buy.

It would appear that for the moment 2.85% on the 10’s and 3% for the 30 year are now the main buy levels. The Eurodollar curve steepened as a consequence due to FRA/OIS widening. The spread will tighten should a large flow occur to absorb the T-bill oversupply. The winners though are those that bet on the flatteners. The yield curve is now at the flattest since 2007.

The yuan strengthened on the day after the PBOC announced that it had tweaked the fixing. However, trade concerns remain firmly on the agenda. The Trump administration is set to impose tariffs on Chinese goods shortly and the Chinese will reply with their own tariffs.

Pork may end up being a political football as once again China’s burgeoning pork industry has disease concerns in the north. This could have a major impact on talks especially if China has to import pork which currently attracts tariffs from the U.S.

In a bizarre twist, Trump suggested that the U.S. may choose to purchase Italian bonds in a bid to support the Italian government. However, with 2 trillion euros in debt there appears to be not a lot Trump could do, nor does the Fed have capacity.

The problem for Italy is that the allure of BTP’s has waned and there appears to be little interest in Italian debt other than domestic. The ECB has already indicated that it will slow asset purchases later this year.

Foreigners shed 58 bio euros of Italian debt in the period between May-June. When this outflow last happened in 2011, Italian banks purchased significant amounts of Italian bonds and gorged on the high yielding bonds for years.

However, for Italian banks this time it is not so easy. Constrained by capital and seeing their bond portfolios losing money, the Italian Banks may not be so keen. Unicredit, for instance, has lost 0.3% in core capital due to the recent sell-off. Declining capital ratios and legacy bad loans could become the focus for investors or even sluggish lending as a result.

Market Recap.

Equities: The S&P rose 0.62% The Dow rose 0.52% The Stoxx 600 rose 0.1%. The Vix closed 11.99.

Currencies: The Bloomberg Dollar Index fell 0.5%. The yen rose 0.1% and the euro fell 0.5% while the pound rose 0.3%.

Bonds: The ten-year closed around at 2.81%. The 2-year closed at 2.62% and the 30-year closed at 2.96%. The ten-year bund closed at 0.34% and the UK gilt closed at 1.275% and the OAT closed at 0.685%.

The U.S. curve flattened on the day and closed on the day with the following closes 2/10 at 18.6 bp, 2/30 at 33.5 bp and the 10/30 closed at 14.79 bp. The U.S. 5-year closed at 2.716%.

Commodities: Crude rose 1.1% on inventory concerns. Gold was steady up fell 1.7% and copper bounced back up 1.5%.

Bitcoin is trading around $6,687.

Aussie Market Today.

The lead for the equity market will come from Asia. Unless concerns mount over tariffs, the equity market could be in for a good day.

Bonds should have a risk off day. Tariffs remain the main concern and the main driver. However, so too yield. Bonds in the U.S. appear to be rallying on this basis and this hunt for yield could also play a part in any rally that occurs in Australia. Expect some drift.

Geopolitical risks remain high.