stuck in a rut for eternity, probably not

European markets took a beating on Wednesday as Turkey and Italy continued to cause investors to run for cover. American markets recovered early losses as Elon Musk’s desire to take Tesla private carries on making the headlines. Indeed, studying Wednesday’s Financial Times one could be forgiven for thinking aside from Elon Musk and Turkey there was little else going on in the financial world

Since early May equity markets have been stuck in something of a rut. The FTSE 100 on Wednesday fell back to 7500, a level it seems to find support at, then at 7700 catches a nosebleed. The S&P 500 once again found 2800 as a point of support to rally from. The Stoxx index of the fifty largest companies in Europe has consistently traded between 3550 and 3650 for most of the year and is likewise back to that support level.

Equities are not the only asset class to be stuck in a trading range as 10-year US Treasury yields rise and fall between 2.8 and 3%. German bund yields between 30 and 45 basis points. The flattening US yield curve again becomes a topic of conversation as the spread between 2 and 10-year US treasury yields further narrows. As economists continue to debate if this a continued harbinger as a predictor of a US recession, we still take the view that is merely a reflection of yields one can get in other parts of the world, particularly Germany. Whilst German 10-year bund yields are no more than 30 or 40 basis points, and the Federal Reserve continue to look to raise interest rates then it seems impossible for US treasury yields to rise above 3% and therefore the curve must flatten.

What is a complete mystery is why German bund yields offer so little, 30 basis points on the 10 year with inflation running circa 2% in the euro area? Many economists will argue it’s a result of the ECB’s QE action. Yet prices have hardly moved as the buying program has wound down. One would surely have anticipated, as the ECB reduce their demand, prices would have risen. Time will tell what message this sends.

For now, it would appear asset prices are stuck in this rut, political uncertainty takes over at the top end of trading ranges, economic growth expectations and a lack of alternatives gives them support at the lower end. Ultimately one will win, however, it is possible this c

Posted on August 17, 2018 .