Don't they know its Christmas?

Bah humbug to the Santa rally as equities around the globe continues to pause for breath. The NASDAQ index so long the driver for equity markets has given back around 2% from its highs, noteworthy but hardly extreme. The catalyst for the selloff in the index appears to be a correction Chinese tech companies seems to be the catalyst to profit taking in the US tech sector. The S&P 500 has pulled back modestly. So far the Vix index does not suggest that investors are getting unduly nervous. Theresa May’s dismal week ensured sterling fell and this helped support the FTSE 100 whilst markets around the globe fared slightly worse.

What continues to mystify with all this positive sentiment around global growth is why bonds remain so much in demand. The yield on German bunds fell below 30 basis points again on Wednesday. The US yield curve has flattened at the fastest rate since 2008.

The Financial Times quoted investors believe the US curve is flattening as the bond market sees a short-term boost from the tax reforms but will have limited impact in the longer term. The greater the likelihood the tax reforms will be passed will also reinforce the Federal Reserve’s desire to raise interest rates. Bill Gross, the former high-profile head of Pimco bond fund interviewed on Bloomberg, also believes that the flattening yield curve is not something investors should be concerning themselves with. There is one phrase quoted from time to time that an inverting yield curve has predicted 15 of the last 10 US recessions.

If one wants to look at another asset class that has rolled over in the past few weeks the Reuters commodity index has fallen almost 5% from its recent highs and the index is now lower than where it started the year. Again, as economists remain convicted that global growth will continue one would expect demand for commodities to increase.

As is always the case at this time Investment banks now start to focus on 2018, and what the year ahead will bring. The big question will be, can the Goldilocks world we have enjoyed, low-interest rates, economic growth and modest inflation continue? Or as some forecast, have we entered a period of irrational exuberance? Is the rise in the Bitcoin another example of liquidity looking for a home? Are other examples the fact that Argentina can raise 100-year debt? An economy that has gone bust on more than one occasion. Another example could be that yields on riskier high yield European debt remain below that of US treasuries. When one goes back to the original point of the flattening yield curve, observing these points one can understand why the US 10-year bond remains in demand at a yield of 2.33%.

Posted on December 7, 2017 .