The Daily Prophet: Bond Traders Just Raised the Stakes Again

Connecting the dots in global markets.

It's as if the bond market is daring the Federal Reserve to raise interest rates again. Looking at the Treasury Department's auction Monday of $26 billion in two-year notes you'd never know that barely two weeks ago the central bank reiterated that it plans to boost rates at least once more this year and multiple times in 2018, while shrinking its balance-sheet holdings.

Traders submitted bids for 3.03 times the amount offered by the Treasury, the highest-bid-to-cover ratio for an auction of two-year notes since November 2015. Soft economic data earlier in the day in the form of a drop in May durable goods orders no doubt played a big role in boosting demand. The broad slowdown in equipment orders and shipments raises the risk that business investment will provide less of a boost than anticipated to the economic rebound this quarter, leaving the heavy lifting to household spending, according to Bloomberg News' Shobhana Chandra. The Citi Economic Surprise Index, which measures data that exceed forecasts relative to those that miss, has fallen to its lowest level since May 2015. With just a few days left until the halfway point of 2017, the Bloomberg Barclays Global Aggregate Index of bonds has gained 4.71 percent, putting the benchmark on track for its best year since 2007.

Though he doesn't vote on monetary policy this year, St. Louis Fed President James Bullard said Friday that the absence of inflation pressures and U.S. growth that is trapped in a 2 percent rut gives the central bank scope for patience. "At least measured by this auction, the buyers are really doubting the path of many more rate hike from the Fed," Peter Boockvar, chief market analyst at The Lindsey Group, wrote in a note to clients. "We all debate this everyday about the mixed messages from the different markets but the Treasury market is speaking loudly about its view on growth and inflation." 

With the bond market showing surprising strength and the economy struggling to gain traction, the debate over the value offered by stocks with the S&P 500 trading at a lofty 19 times projected earnings is even louder than usual. To Brian Nick, the chief investment strategist of TIAA Investments, watching stocks today is like how a parent would watch a child traverse a jungle gym. “When I see my 2-year-old son on the playground, if he’s really high, I’m not worried that he’s more likely to fall. I’m just worried that if he does fall it’s going to be worse,” Nick said Monday in an interview on Bloomberg Television. Options contracts that pay off with a drop in the S&P 500 outnumber those betting on a gain by a rate of more than 2-to-1, the most since January 2016, data compiled by Bloomberg show. Since the start of the bull market eight years ago, the S&P 500 has lost 0.3 percent in the 10 days following put-to-call ratios at or above the current level, compared with a 0.6 percent gain in all 10-day stretches during that period, according to Bloomberg News' Oliver Renick.

The big news in international markets happened in Italy, where stocks and bonds jumped after the government in Rome announced the country’s biggest bank rescue to date on Sunday evening as it committed as much as 17 billion euros ($19 billion) to clean up two failed institutions. The FTSE MIB index of equities rallied 0.81 percent, the most among euro-area benchmark and four times the gain in the MSCI All-Country World Index. Italy's bonds market, the third-largest in the world, delivered gains as yields fell to about their lowest of the year relative to German bunds. The intervention at Banca Popolare di Vicenza and Veneto Banca includes state support for Intesa Sanpaolo to acquire their good assets for a token amount. Italy tried for months to find a way to keep the banks afloat, appealing to wealthy businesspeople to contribute to a rescue, according to Bloomberg News' Sonia Sirletti and Alexander Weber. Although the European Commission approved the plan, Germany pointed to the involvement of state aid to shield senior creditors from losses as working around EU law established to deal with bank failures. The exemption drew criticism from members of Chancellor Angela Merkel’s ruling coalition, who cited the need to uphold European law without setting unhealthy precedents, according to Bloomberg News' Rainer Buergin and Birgit Jennen.

Everything was going swimmingly in the market for gold until 9 a.m. in London. That's when a huge spike in volume in New York futures that traders said was probably the result of a "fat finger," or erroneous order. Trade shot up to 1.8 million ounces of gold in just a minute, a level not reached even with the surprise election of President Donald Trump or Britain’s vote to leave the European Union, according to Bloomberg News' Eddie van der Walt and Susanne Barton. “No one has a clue, apart from the unfortunate individual that pressed the wrong button,” David Govett, head of precious metals trading at Marex Spectron Group in London, said of the spike in volume. Others said a trader may have made a larger order than intended, or underestimated the market’s ability to absorb so much gold. Some speculated the sell-off may have been prompted by technical reasons, with gold probing a critical level of resistance at $1,255 an ounce. Whatever the reason, the rising use of computer-driven algorithmic trading has often been blamed in recent years for extraordinary movements in short periods of time in financial markets in what has become known as flash crashes.

It was another big week for inflows into emerging markets, as investors added more than $500 million to exchange-traded funds that buy developing-nation stocks and bonds, according to data compiled by Bloomberg. Inflows have exceeded $19 billion over the past 16 weeks. Money going into U.S.-listed emerging market ETFs that invest across developing nations as well as those that target specific countries totaled $520.9 million, compared with $406.4 million in the previous period. Fund assets have grown $27.5 billion so far this year. Last week, stock ETFs expanded by $388.5 million and bond funds added $132.4 million. The biggest inflows were in China and Hong Kong, where funds grew by $130.4 million, compared with $67.2 million the previous week. Last week was also when MSCI Inc. said 222 mostly large-cap mainland China shares would join its benchmark indexes. Goldman Sachs said $430 billion could flow into the market if China can make it to full inclusion. Investors added $125.4 million to stock funds and $5.04 million to bond ETFs.

The Bank of England's Financial Policy Committee on Tuesday will provide its assessment of the stability of the U.K.'s financial system in its biannual report. The FPC's assessment of consumer borrowing is also likely to garner a lot of attention, as unsecured credit is growing at the fastest pace since 2005, according to the economists at Bloomberg Intelligence. The willingness of households to borrow was a big reason the economy remained resilient after the Brexit vote in June 2016, the economists wrote in a note. It isn’t clear, though, whether there will be any specific policy recommendation at this point, according to a strategist at Royal Bank of Canada. Sterling has been whipsawed the last couple of weeks, first by a botched election campaign that raised new questions over Britain’s membership in the European Union, then by conflicting remarks from central bank officials over the strength of the economy and inflation.

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