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Equity rally slows - AM Bulletin
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Dollar holds recent gains - AM Bulletin
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15 Nov 2016
Dollar soars as bonds slide - AM Bulletin
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 Tuesday 15 November 2016

Dollar soars as bonds slide - AM Bulletin

 

 

Indices Update

Investors continue to reassess and reposition themselves following Donald Trump’s unexpected victory last week. The most extreme reaction has been in the bond market where the yields on some of the most important US Treasury issues have risen to levels last seen at the beginning of this year. The 30-year Treasury bond yield is over 3% for the first time since January. This is highly significant as investors have been piling into the bond market at an extraordinary rate ever since the financial crisis of 2008/9. The dollar has also shot higher as investors calculate the effect of a Trump presidency. The overarching opinion is that Mr Trump will push ahead with tax cuts, both corporate and personal. On top of this one of Mr Trump’s campaign promises was to introduce a $1 trillion programme of infrastructure spending. All these policies (if enacted) would boost wages, drive down employment and lift growth. However, they would also be highly inflationary and would see the US running eye-watering budget deficits and add directly to the national debt. Likewise, any attempt to curb, let alone reverse, immigration will put upside pressure on wages, while the threat of tariffs could be very damaging for trade and also boost prices.

For the time being, equities are benefiting as investors shift out of bonds and seek out those corporate sectors which could do best under a Trump presidency. This has led to a significant sector rotation which has seen a move out of tech stocks and into the big “old school” corporations found in the Dow Jones. However, it’s worth remembering that many bond market speculators use high levels of leverage. If the sell-off turns into a rout, it won’t be long before investors have to ditch equities as well to lighten up on losing positions and pay margins. There’s no sign of this happening yet as we’re still witnessing a number of rotations going on. It’s also worth bearing in mind that a strong dollar will impact negatively on US multinationals as it makes US goods more expensive for foreign buyers. So it’s worth being cautious and waiting to see if we’re experiencing a short-term readjustment or something more long-lasting.

Yesterday brought the release of some mixed data from China. Fixed-asset investment rose 8.3% for the year to October, beating market expectations. But October industrial output and retail sales growth missed forecasts.

The FTSE 100 ended the day 22.8 points higher at 6,753.2

The German DAX rose 25.7 points or 0.2% to end the day at 10,693.7

The US30 closed 21 points higher to finish at 18,868.7 The S&P 500 ended down 0.3 % at 2,164.2 while the Nasdaq 100 fell 1% to close at 4,702

Equities

The sector rotation which was such a feature of last week’s trade was much in evidence in London yesterday. Banking stocks topped the FTSE100 with Barclays (BARC) ending the session up 5.2% while RBS (RBS) was up 4.4%. Banks were back in demand on hopes of relatively lighter US regulation and expectations that a rise in inflation could prompt the Federal Reserve to raise interest rates at a faster pace than previously anticipated. This would help boost lenders’ profit margins. But it was utilities that felt the brunt of the selling. Shares in utility providers are typically viewed as bond-proxies. Consequently, investors were quick to lighten up on their holdings given fears that inflation looks likely to pick up now while the US budget deficit should widen if president-elect Trump follows through on his promised infrastructure spending spree. Severn Trent (SVT) was the worst performer in the FTSE100, ending the day 3.8% lower. SSE (SSE) fell 3.2% while United Utilities (UU) closed down 2.8%. 

Commodities Update

Crude rallied in early trade on Tuesday. There has been some speculation that US shale output is coming in below expectations. On top of this, some commentators have discussed the possibility that oil industry giant Harold Hamm could be Mr Trump’s energy secretary. But the latter shouldn’t be particularly positive for the oil price as it looks as if Donald Trump is set to reduce regulation and make it easier for oil companies and drillers to start up new projects.

Crude oil sold off last week after Donald Trump clinched the US presidency.  Yet ultimately, oil traders seem far more concerned about the outlook for global supply and demand and the OPEC meeting later this month than with the Trump presidency. Yesterday WTI hit its lowest level since early August.

At the end of last week OPEC reported that its output hit a fresh record in October of 33.64 million barrels per day (bpd). This was a touch below an estimate from the International Energy Agency (IEA) when it reported that OPEC’s output in October came in at 33.83 million bpd, driven by production recoveries by Iraq, Libya and Nigeria. Nevertheless, even OPEC’s lower figure is way above the 33.24 million bpd from the previous month.

At a meeting in Algeria back in September OPEC announced a plan to cut production. The trouble is that Iraq, Libya, Nigeria and Iran are all insisting they should be exempt from any cuts. The question then is which OPEC members will end up shouldering a reduction and the accompanying loss of income? The answer is most likely to be none. Saudi Arabia is the only country that could make a significant cut. However, the Kingdom is in trouble and struggling to cope with its high social welfare commitments with oil below $50. On top of this, if the effort to limit output to boost the oil price is going to be effective, it will need some kind of agreement from non-OPEC producers as well. This seems most unlikely.

Gold and silver had another torrid trading session yesterday. Yet again, sellers were out in force and drove both metals lower. Both precious metals hit their lowest levels since the beginning of June this year. And both have broken below significant support levels. This is making it difficult to pinpoint effective support areas for either metal. Silver may need to pull back towards $16 before it has a chance to consolidate properly. What a difference a week makes. Last Wednesday it had poked its head above $19. It was also outperforming gold as investors hoovered it up, betting on increased industrial demand. Now all they’re bothered about is the soaring dollar and how much higher it can go. The situation is similar for gold. Less than a week ago gold had shot above $1,330 while the dollar slumped. However, gold has since fallen sharply while the greenback has soared as investors anticipate a jump in inflation on the basis of Trump’s campaign promises. Those promises included sweeping tax cuts and waves of fiscal stimulus in the form of infrastructure spending. The thinking goes that Trump’s proposed tax cuts and fiscal stimulus will kick-start growth and boost inflation. Higher interest rates will follow, lessening gold’s appeal.

Forex Update

The US dollar continued to soar yesterday. At one stage the Dollar Index broke above 100 to hit its highest level since December last year. Yet less than a week ago the greenback plunged after it became apparent that Donald Trump was on course to win the presidency. The Dollar Index tested support around 96.00 during election night but then swung round and went on to break above 99.00 the following day. The turnaround in the dollar came as investors reassessed the outlook for inflation in light of a Trump presidency. Investors expect to see wide-ranging tax cuts, both corporate and personal. During his campaign Mr Trump promised to slash and simplify the tax system for individuals and slash the corporate tax rate to 15% from 35%. He has also proposed a one-off tax break for US multinationals which would encourage them to repatriate the hundreds of billions of dollars in profits held overseas.

Then there is the promise of fiscal stimulus in the form of infrastructure spending. This is what so many neo-Keynesian economists have been demanding for years now, arguing that austerity measures have compounded the slowdown in economic activity since the financial crisis. But government spending will mean bigger budget deficits and even more national debt.

Meanwhile, investors are also looking ahead to next month’s Federal Reserve monetary policy meeting. Fed members have been particularly hawkish since September and have given out strong signals that they are preparing to raise rates before the year-end. At the end of last week Fed Vice-Chair Stanley Fischer said that the case for removing accommodation was "quite strong" and that the Fed is close to achieving its dual mandate. It’s worth remembering that the Fed has spent all this year signalling their readiness to hike rates and then ducking out at the last moment. But if they fail to hike in December they really will lose their last wisp of credibility and this is what the bond market is telling us.

Upcoming events

Today’s key economic data releases and events include Italian Preliminary GDP, German ZEW Economic Sentiment survey, UK CPI, RPI and Inflation Report Hearings from the Bank of England. From the Euro zone we have GDP, the Trade Balance and ZEW Economic Sentiment survey. From the US we have Retail Sales, Import Prices and the Empire State Manufacturing Index.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: AM Bulletin


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