Stocks, Bonds or FX: Which is Irrational?

Wednesday December 21: Five things the markets are talking about

Stocks, the dollar and U.S yields are trading at lofty heights on the “potentials” of Trump’s fiscal stimulus packages – details not yet disclosed. Nevertheless, one of these asset classes, more than the others, does seem to be out of sync with reality.

Last week, the Fed’s Yellen questioned the wisdom that fiscal stimulus will have on a ‘full employment’ economy by stating that “fiscal stimulus so late in the expansion cycle will almost certainly be met with more rate hikes.”

With the U.S economic slack near ‘non-existent,’ Trumponomics should be expected to support more inflation rather than growth. If so, this will force the Fed to up the ante and tighten monetary policy at a much faster pace than fed fund futures are currently pricing in – currently three-rate hikes by Q4. This justifies the reason why the mighty dollar is perched atop of its 14-year highs and why U.S 10-year treasury’s has +2.75% in its sight. It’s the risks to risky assets or stocks that remains the big unknown.

There is no doubt that human nature will push U.S equities to new highs, but how sustainable is that when accommodation is taking away at a much faster pace and while stimulus packages don’t meet expectations?

Is it prudent to considering take some of the “froth” off equities and bank it?

1. Mixed results from global stocks

With the DJIA closing out just shy of the psychological 20k barrier helped to push Asian indices higher overnight.

In APAC, Australia’s ASX 200 closed up +0.4%, while Singapore’s Straits index gained +0.1%. In China, equities rebounded from a six-week low amid optimism of a renewed reforms push – the Shanghai Composite ended up +1.1%.

In European, equity indices are trading generally lower as banking stocks weigh on the indices. The Spanish IBEX is underperforming after the EU’s ruled against Spanish banks over mortgage interest repayments. The FTSE 100 is being supported as energy stocks are generally trading higher across the board.

U.S futures are set to open flat.

Indices: Stoxx50 -0.2% at 3,273, FTSE -0.1% at 7,040, DAX flat at 11,467, CAC-40 -0.3% at 4,386, IBEX-35 -0.8% at 9,335, FTSE MIB -0.4% at 19,174, SMI +0.1% at 8,252, S&P 500 Futures flat

2. Oil finds support, gold prices mixed

Crude oil has found a small bid ahead of the U.S open on yesterday afternoon’s API data that showed a +4.1m barrel decrease in U.S. crude stockpiles.

Dealers could take prices even higher today if the amount is confirmed by the U.S. EIA report mid-morning (10.30am EST).

Brent crude oil futures are at +$55.57 a barrel, up +22c, while U.S. light crude (WTI) futures are trading at +$53.58 per barrel, up +28c from the close.

In the absence of fundamentals over the holiday period, investors can expect the technical support and resistance levels to become more of the price drivers.

Gold has rallied +0.3% ahead of the U.S open to +$1,135.55 an ounce, after closing near its ten-month yesterday as concerns eased over geopolitical events.

3. Fixed income back to the U.S reflation trade

Prices of U.S. government bonds have pulled back, reversing the early week’s rally on risk-aversion.

The yield on U.S 10’s is at +2.565% vs. Tuesday’s close of +2.556%. The pressure on bond prices certainly reflects investor’s optimism over the economy and fiscal stimulus. If Trump disappoints, treasuries will quickly give up a fair bit of its interest rate premium.

Elsewhere, 10-year debt yields in New Zealand, Australia and Indonesia moved higher, while similar-maturity debt yields in South Korea, Singapore and Malaysia edged lower.

Note: Don’t be surprised that due to the holiday shortened trading and thin liquidity that fixed income finds a bid into the turn.

4. Dollar pouts in quiet overnight session

The dollar index (DXY) has edged down -0.1% overnight after settling at a 14-year high yesterday.

The Euro’s single unit is up at €1.0399 after record capital outflows contributed to pushing common currency close to parity with the dollar for the first time since 2002 yesterday. The pound has extended its losses slightly, to around £1.2331, down -0.2% on the day, after the U.K. public finances data showed larger levels of borrowing than expected (£12.6B vs. £12.3). The yen has caught a bid with the dollar down -0.3% at ¥117.58.

The SEK was up +0.7% outright SEK$9.27 after the Riksbank left its main interest rate unchanged (see below).

5. Sweden’s Riksbank stands pat

Earlier this morning, Sweden’s Riksbank extended its bond-buying program and left its interest rate unchanged to ensure the pace of inflation continues to pick up towards its +2% target.

Policy makers raised their bond-buying target by +30B SEK to +275B by the end of June next year and said it would keep its main interest rate at a record low of -0.5%.

Like other NIRP’s, the Riksbank walks a fine line as it strains to hit its inflation target without causing the Swedish economy to overheat. In the accompanying communiqué, policy makers expect to start raising rates in early 2018 when a rise in inflation is secured.

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