IT’S 2007 AGAIN!

Friday saw the positive tone for equities maintained as the same old chestnut reappeared. You see, equities reacted because inflation remains in a somewhat stagnated form and it is expected the Fed may not hike three times this year and maybe even two could be difficult.

As such, the equity market continues to rally not on increased profits but rather on a weakening economy and an economy that is failing to fire. The tax cuts are driving the rally at present as companies are using the extra cash to purchase shares by way of a share buyback and increased dividends. The impetus to the economy is not being provided by tax cuts at this stage.

U.S. import prices rose less than expected to gain 0.3% for April. The Philadelphia Fed saw core PCE index averaging 2.0% in the second quarter compared to 1.9%.

And one for the equity bulls. James Bullard, the President of the St Louis Fed, suggested that rates were at the “neutral level” and that no more rate hikes were required. If this is true, it paints a gloomy forecast for U.S. manufacturing capacity. However, it will spur the equity bulls into more frenetic buying.

So how did the bond market react? The yield curve on Friday is the flattest it has been since 2007. The 5/30 year closed at 26.2 bp whilst the 2/10- spread closed at 41 the flattest since 2007. The recent bond auction of $73 bio of new supply was met with strong demand.

For bond bears, they are betting that inflation will rise and that economic growth won’t be as strong, leading to a deficit blowout. A blowout would lead to the Treasury selling more treasuries and prices falling as yields rise.

The market has the Fed hiking rates in June at 100% according to the CME Fedwatch Tool. For a hike in September, the market has the odds at 73.6%. Interestingly, that’s shortly before the next reload of the Debt Ceiling that is due to expire around October.

For the interested bond parties, it is interesting to note that some of those easy documents for junk-rated companies are becoming a little tougher. In addition to extra spread, investors are starting to require more protections for investors.

Bond buyers are clawing back a little on leverage. The spread between junk bonds and Treasuries slid to 3.24% in April, just 1 point shy of the narrowest that spread has been since 2007. The spread has pushed back to 3.43% with increased covenants.

And in a move for the French, the High Council for Financial Stability has set a cap of 5% on highly indebted French companies. The exposure limit is for two-years and includes the Central Bank. The six largest French banks are covered by the limit.  The limit comes as a result of surging corporate borrrowings which picked up gains in March to expand at 5.2%. Bond issuance surged at 7.3%.

Geopolitical risks appear to be abating at present now that Trump will meet Kim in Singapore. The historical meeting will be a fantastic success if the North Koreans withdraw their nuclear ambitions. There is a caveat and that is the great unknown.

For the moment Trump’s initiatives are laudable, but we don’t know how much pressure Xi Peng, the Chinese President, has put on Kim especially when the lever used by Trump on Xi Peng is traded. Either way, it will be a fantastic result if a conclusion to the Korean Peninsula is finally resolved.

The next big issue then becomes Iran. How Trump will deal with the Iranians is unclear and the same holds for the Iranians with Trump. A number of European corporates would be hurt by a trade embargo whilst Iran already has major trading partners such as Russia and China and is not as dependent on these countries as North Korea is with China. The scenario is interesting, and geopolitical risk has not diminished yet.

 

Recap.

Equities: The S&P 500 closed up 0.17% The Dow rose 0.37%. The Stoxx rose 0.11%.

Currencies: The Bloomberg Dollar Index was unchanged. The euro surged 0.3%.

Bonds: The ten-year closed around at 2.97%. The 2-year closed at 2.539% and the 30-year closed at 3.102%. The ten-year bund closed at 0.56% and the UK gilt closed at 1.443% and the OAT closed at 0.789%.

The U.S. curve closed the day with the following closes 2/10 at 43.1 bp, 2/30 at 56.5 bp and the 10/30, closed at 13.1 bp. The U.S. 5-year closed at 2.838%.

Commodities: WTI fell 1.1%.  Gold fell 0.2%.

Bitcoin is trading around $8,721 after some raids on Bitcoin holdings in Korea.

 

Aussie Market Today.

The Aussie market should see equities continue to rally. The mood looks positive for the moment.

Bonds will prove to be a little jumpy on the day. I expect to see a slight weakening on the day as yields drift higher.

Aussie to be steady on the day.