Its good of the FT to highlight some of the issues of the day ..... we can check that we're at least vaguely "au fait" with some of the things that matter to markets. Of course definitive answers to their own questions are not on offer but certain possible outcomes are suggested, some of them more concerning than others.
More bond market pain for China's equity investors ?
Recent weakness in Chinese equities is catching plenty of attention ..... the CSI 300 index, a composite of stocks from Shanghai and Shenzen and currently in fashion as THE indicator to follow, suffered its largest one-day fall for 17 months last week and continues on the defensive. Any minor correction will have the bulls wary of signs of something more substantial, but since the index is still up 22% on the year they won't be overly anxious yet. But if it's signs they're looking for, they'll have to look a bit further afield.
The move in equities is really all about a move in bond yields, and thus a function of China's debt problem ..... or more accurately, of attempts to address it. Equity traders have been pretty relaxed about climbing bond yields over the last 12 months, with the yield on the 10yr sovereign bond rising from about 2.90% a year ago. But as the authorities expand their efforts to curb leverage and excessive corporate borrowing by tightening financial conditions, last week's look above 4.00% was deemed significant, especially against a background of a reflating economy.
The potential for a much larger reversal in equity prices plainly exists ..... particularly if the 4.00% 10yr yield barrier is convincingly broken and bond yields take another leg up. We're not there yet, though .....
Does the flatter US yield curve matter ?
A good question, and a subject of much debate ..... we've talked about it a good deal ourselves. Notwithstanding the changes at the top of the Fed, the central bank remains of the view that growth will remain decent and even if inflation is not behaving as it should, on balance the belief is that sooner or later it will kick in. Hence a gradually tighter monetary policy that indicates a rate hike next month, and three more next year.
Bond market yields suggest something else ..... longer-term, lacklustre growth and moribund inflation as reflected by the suppression of longer-term yields even as short-term benchmark rates are hiked. That of course means yield curve flattening ..... the difference between the 2yr and 10yr Treasury yield has narrowed from 126 basis points to about 58bp this morning. But the question was : does it matter ?
Well, of course it does in the sense that the yield curve reflects the market's view of what's ahead. But does it portend something really nasty ? Curve flattening is one thing, but actual inversion of the yield curve (short term rates higher than long term rates) is another. They say that a recession is preceded by a curve inversion , and they're right ..... almost every time over the last 70 years, in fact. We're still some way from the curve inverting, but Morgan Stanley have just predicted a completely flat yield curve by the end of 2018. Cause for concern, surely ?
True enough, and the curve will be closely watched ..... but before we assume too much, there's one more thing that they don't always tell you : recessions may follow within two years of the curve inverting, but there have been NINE occasions since 1960 when there has NOT been a recession after a curve inversion. There are plenty of special factors around that are keeping long yields down just now, such as QE and the resulting search for yield from investors outside of the US as well as inside. You could very reasonably make an argument that should the curve actually go that far, this occasion might be the tenth.
Is the euro due another rally ?
To quote the FT, "not yet but the signs are favourable". We can see the rationale : This year's rally has largely been a function of dollar weakness ..... we might see some year-end book-squaring, which is to say the buying back of short-dollar positions, but in 2018 the market will be able to focus on eurozone growth, which is getting stronger by the day it seems and will be much more of force that it was during the euro's 2017 rally.
Political problems in Germany have not fazed the market, and the consensus is growing that a stable solution to those problems will be found anyway. The risk of the German economy overheating is growing, with all its attendant implications of upward pressure on rates, or at least an earlier end to QE.
Credit Suisse have just raised their 12-month forecast for EUR /US$ from $1.15 to $1.22 ..... which is certainly very plausible. But then again, we know all about the track record of year-end predictions, don't we ?
P.S. Bitcoin trading through $9,900 today, ever closer to the symbolic $10,000 level. Michael Novogratz, "hedge fund legend", says it could hit $40,000, repeat $40,000, by the end of 2018. Presumably, he's got a few ......