The Daily Prophet: China (Almost) Sends Markets Into a Tizzy
(Bloomberg View) -- There was a time when the mere speculation that China might eventually pull back from its purchases of U.S. Treasuries would send world markets in a tizzy. No longer. Although bonds, the dollar and stock futures did take a hit when news broke overnight that senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of Treasuries, markets recovered all or most of their losses during U.S. trading hours.
In other words, if China -- whose more than $1 trillion of Treasuries is exceeded only by the Federal Reserve's holdings -- was hoping to send a message to the U.S. with the White House said close to announcing tariffs on a number of Chinese goods, it failed miserably. That can be seen in the results of the Treasury Department's auction Wednesday of $20 billion of 10-year notes. Bids from investors exceeded the amount offered by 2.69 times, the most since 2016. In many ways, traders realize China is stuck. If it tries to jawbone the Treasury market lower, it will inflict massive losses on itself given its huge holdings. Plus, at almost $15 trillion, no other government bond market comes close to the size or liquidity provided by Treasuries. Lastly, rates on U.S. debt are attractive relative to the trillions of dollars of negative yielding bonds found in Europe and Japan.
FTN Financial economist Chris Low noted that when China stopped buying Treasuries in the past, there were suggestions that politics was involved and yields surged. Ultimately, though, that led to a "hugely profitable trade" that made China's foreign-exchange managers look like "heroes" as they were then able to buy cheaply and reap big gains when the market rebounded, Low wrote in a research note.
DITCH THE ADVISER AND JUST BUY THE DIP
Although history will show Wednesday was a down day for stocks, the real story was the big recovery in the S&P 500 Index, proving that no strategy is more powerful right now than "buy the dip." The benchmark fell as much as 15.23 points in early trading, or 0.55 percent, before ending the day down just 3.06 points, or 0.11 percent. Surely, the bears will say that investors are too complacent about the risks facing the economy, but it's hard to dent the positive sentiment with companies about to report robust fourth-quarter earnings and the World Bank boosting its U.S. growth estimate this year to 2.5 percent from a prior forecast of 2.2 percent. Yet even the bulls can't help being on edge after the big rally left the S&P 500 trading about 10 percent higher than its 200-day moving average. That's the biggest gap since 2013, according to Bloomberg News' Elena Popina. That doesn't mean an imminent pullback is in the cards. But it does suggest stocks are priced for perfection and any disappointment, whether it be in profits, the economic data or politics, could send equities lower.
NOTHING IS STOPPING OIL
Everyone seems to be marveling over the relentless rally in stocks in the face of rising geopolitical tensions, discord in Washington and central banks that are starting to pull back from ultra-loose monetary policies. But the gains in equities can't compare to what's happened with oil. Crude closed above $63 a barrel on Wednesday for the first time in more than three years, bringing its gain since the end of June to almost 38 percent. That compares with an increase of just over 13 percent for both the S&P 500 Index and the MSCI All-Country World Index of stocks. Although OPEC gets the bulk of the credit for the rise in prices amid the longest winter decline in U.S. crude stockpiles in a decade, other factors are also at play, including strong refining margins, frigid weather and robust foreign demand, according to Bloomberg News. Citigroup's strategists wrote in a research note this week that oil could rise to between $70 and $80 a barrel on wildcards including war, Middle East tensions, Donald Trump and Kim Jong Un, reports Bloomberg News' Sharon Cho. “Many of these uncertainties have significant consequences for commodities,” the strategists wrote in the report.
NAFTA CURRENCY SURPRISE
Currency traders received a jolt when news broke during the afternoon that Canadian government officials see an increasing likelihood Trump will give six-months’ notice to withdraw from Nafta. A sixth round of negotiations will begin this month in Montreal. Canada has escalated its trade spat with the U.S. by filing a World Trade Organization complaint over American duties against Canada and other countries, according to Bloomberg News' Josh Wingrove. U.S. Trade Representative Robert Lighthizer responded earlier Wednesday, calling that move a “broad and ill-advised attack.” The currencies of Canada and Mexico promptly dropped, becoming two of the biggest losers of the day against the dollar. "If the news report gets more confirmation -- other sources or U.S. officials, something like that -- then the peso’s weakness could be sustained and extended," Danny Fang, an analyst at BBVA, told Bloomberg News.
JUNK BOND MARKET GET LESS JUNKY
No discussion about which markets might be in a bubble would be complete without mentioning junk bonds. After all, U.S. high-yield bond spreads just hit a post-financial crisis low of 3.20 percentage points amid investor euphoria stoked by rising equity and commodity markets, according to Bloomberg News' Gowri Gurumurthy. The bulls, though, say there's good reason to pay up for junk bonds as the market is becoming less, well, junkier. S&P Global Ratings said Wednesday that the number of so-called weakest links, or issuers rated B- and lower with negative outlooks or CreditWatch with negative implications, has dropped to 198 worldwide, the least in two years. It's rival, Moody's Investors Service, said just 90 defaults were recorded in 2017, down from 143 in 2016. It projects the global speculative-grade default rate will drop to below 2 percent this year from 2.9 percent at the end of 2017.
Investors will soon find out whether the auction of 10-year Treasuries was a fluke or not. That's because the U.S Treasury will auction $12 billion of 30-year bonds on Thursday. Despite bond rates still being near historic lows, at about 2.90 percent the yield on the 30-year Treasury is higher than the 0.85 percent offered on Japanese government bonds, the 1.32 percent offered in Germany or the 1.82 percent than can be had in the U.K. In fact, U.S. yields are even higher than those on bonds in Spain, which has a lower credit rating, Slovakia, Ireland and even Latvia. At the last auction of 30-year Treasuries in March, the bid-to-over ratio was 2.48, or the high end of the range of the past two years despite yields being near the lows of the year, or at about 2.70 percent. What that means is if you liked bonds then, you probably love them now.
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Robert Burgess is editor of Bloomberg Prophets.
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