(Bloomberg View) -- For a market that has been all but given up for dead in recent weeks, there sure is a lot of demand for bonds. Even though the Federal Reserve raised interest rates three times last year and has forecast another three increases for 2018, the U.S. government on Tuesday was still able to attract the most demand at an auction of two-year Treasuries since 2015.
Investors placed bids for 3.22 times the $26 billion offered, above last year's average of 2.82 times and leading strategists to describe the results in client notes as "solid." What's also remarkable is that investors showed in droves at the auction even though U.S. Treasury is poised to outline a plan to ramp up debt sales for the first time since 2009 to fund budget deficits that are likely to deteriorate for years to come. Perhaps the demand is a reflection of doubts that the Trump administration's tax cuts will add much to economic growth or worries that the big rally in high-risk assets such as stocks and junk bonds has gone too far and is due for a reversal. Whatever the reason, there's no denying that yields on the U.S. are higher than investors can get just about anywhere else in the developed world.
U.S. Treasury two-year notes yield 2.04 percent, up from less than 1.20 percent as recently as April and much higher than the negative yields offered on similar maturity bonds of countries including Germany, France, Spain, Italy and Japan. The auctions continue Wednesday and Thursday, when the Treasury Department sells $15 billion of two-year notes with floating rates, $34 billion of 5-year notes and $28 billion of seven-year notes.
BANK OF AMERICA CATCHES A CASE OF FOMO
The equity strategists at Bank of America joined a growing legion of firms that have raised their forecasts for the S&P 500 Index, but they don't seem very excited about doing so. In increasing their year-end target for the benchmark to 3,000 from 2,800, the strategists cited improving but not yet extreme sentiment and a likely bigger-than-expected boost to earnings from tax reform. At the same time, the strategists warned investors to watch out for trouble signs, noting that 11 of the firm’s 19 bear market signposts, including Fed rate increases, have been triggered, according to Bloomberg News' Lu Wang. The median year-end estimate in a Bloomberg News survey of strategist is 2,950. In terms a of sentiment, a Bloomberg measure of the appetite for risky assets that incorporates 18 different metrics across a broad range of markets rose Tuesday to its highest level since mid-2015, which just so happened to precede the worst quarterly performance for the S&P 500 since 2011, with the gauge dropping 6.94 percent between the end of June and the start of October.
ANOTHER REASON TO DISLIKE THE DOLLAR
The Bloomberg Dollar Spot Index fell on Tuesday to its lowest level since the start of 2015. The reason most strategists have given for the dollar's weakness in the face of last year's three rate increases by the Fed is that other currencies are benefiting from stronger local economies. Lately, though, some strategists such as those at FXTM are starting to see the declines as a reaction to the Trump administration's stance on trade, which could weaken trade globally and damp demand for dollars. Whether that's true or not, it's notable that the latest International Monetary Fund data released at the end of last year showed that the dollar's share of global currency reserves fell in each of the first three quarters of 2017, dropping to 63.5 percent from 65.3 percent at the end of 2016. If concerns over trade policies are a reason for the dollar's decline, then things may just be heating up after President Donald Trump took his first big step toward erecting trade barriers on Monday by slapping new “safeguard” duties on solar-panel and washing machine imports to protect U.S. industry.
EMERGING MARKETS REACH UNPOPULAR MILESTONE
It's been good to be an investor in emerging markets. The MSCI Emerging Markets Index of stocks soared 34.4 percent last year, topping the 21.6 percent gain in the MSCI All-Country World Index. Yield spreads are at about their narrowest levels of the last decade. An index measuring the strength of EM currencies is the highest since 2011. Now, a report from the Institute of International Finance says fund investors' exposure to EM has reached its highest level since April 2015 after a third, or $35 billion, of the $110 billion that has flowed into global mutual funds and ETFs since mid-November has targeted EM. Investors may take pause at the April 2015 date, because that's when EDM started a painful nine-month slide that took the MSCI EM Index down by 35.5 percent. It took until July of last year for the index to surpass the April 2015 levels. Of course, EM nations are in much better fiscal shape, but those losses are probably still fresh in the memories of investors.
GOLD INVESTORS SWAMP FUNDS
Of the many reasons to be worried about the current euphoria sweeping markets, one of the least talked about is the rising demand for gold. After all, gold is seen as a haven in times of turmoil, but turmoil seems to be the last thing on the minds of most investors these days. Of course, a weaker dollar is helping the precious metal, since it is priced and traded in the U.S. currency, but it's hard to say that's the sole reason behind the demand. The other reason is that investors see signs of faster inflation. As such, they are piling into exchange-traded funds backed by gold, pushing assets to the highest in more than four years, according to Bloomberg News' Susanne Barton. Holdings climbed to 2,250 tons on Monday, the highest since May 2013, according to data compiled by Bloomberg. “Investors are once again looking to gold as a potential inflation hedge,” Suki Cooper, an analyst at Standard Chartered, wrote in a note to clients Tuesday. “Gold tends to perform well as an inflation hedge if it is bought before inflation picks up and in periods of high inflation.”
The first indication of how well Europe's economy has started the year comes Wednesday with the preliminary release of IHS Markit's monthly manufacturing index. Although the median forecast is for little change, with a reading of 60.3 versus 60.6 in December, that wouldn't be a disappointment considering that last month's results were a record high. The same is true of the composite index, which includes service industries. Currency traders have taken notice, pushing the Bloomberg Euro Index up 9.78 percent over the past 12 months to its highest levels since 2014. At the least, the IHS Markit report will provide a nice setup to the European Central Bank's monetary policy decision on Thursday. While no action is expected this week, almost half of respondents in a Bloomberg survey predicted the ECB will announce a definite end-date for asset purchases by June.
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Equities Face Unprecedented Earnings Expectations: Jim Bianco
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Robert Burgess is editor of Bloomberg Prophets.
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