The Daily Prophet: Bond Traders Have Lost Their Holiday Spirit

Connecting the dots in global markets.

The bears are running wild in the bond market. A swift selloff in longer-maturity Treasuries over the past three days has pushed 30-year yields up by the most this year.  The pain isn't limited to the U.S. Yields on German, French, U.K., Canadian and Japanese sovereign debt have been bit hard, as well.

Although investors and strategists say the usual year-end lack of liquidity may be exacerbating moves, there's nevertheless a growing sense of worry that this mini-slump could very easily turn into a major slump. The markets' tailwinds are rapidly turning into headwinds, from an increase in debt issuance to finance a growing budget deficit to central banks turning from dovish to hawkish to incipient signs of faster inflation. For example, JPMorgan forecasts the U.S. in 2018 will sell the most debt in eight years, estimates net issuance at $1.3 trillion, more than double this year’s tally. Sweden’s Riksbank on Wednesday formally ended a program of bond purchases after almost three years, becoming the latest central bank to turn less accommodative, according to Bloomberg News' Brian Chappatta and John Ainger. In the U.S, the market-implied annual inflation rate for the next decade reached about 1.95 percent Wednesday, the highest since April.

"Sentiment has zero tolerance for surprise given uncertainties that will follow passage of tax reform" in the U.S., Jim Vogel, an interest-rate strategist at FTN Financial, wrote in a research note. "Year-end jitters are rampant."

EVEN STOCKS' TOP LINE LOOKS EXPENSIVE
There's a big debate among investors about whether the lofty price-to-earning valuations for U.S. equities reflect the potential for higher profits now that the corporate tax rate has been lowered. Regardless of the answer, there's another metric showing that equities are very rich. Four straight weeks of gains have pushed the S&P 500 Index to 2.3 times the revenue generated by its members, a level not seen since the waning days of the internet bubble, according to Bloomberg News' Elena Popina. Even then it was far from standard: The S&P 500 traded at or above this valuation on 27 days in 1999 and 2000, data compiled by Bloomberg show. Like many valuation indicators, price-to-sales has inflated during a year when stocks reached a record on average once every four days, though other measures such as price-to-earnings and price-to-book are still a ways away from their dot-com zenith. To a skeptic, that’s because there are fewer ways of juicing the sales line. “You can’t play around with sales number, and the fact that the number is this high may be a good reason to stop for a second and think,” Matt Maley, a strategist at Miller & Tabak, told Bloomberg News.

THE KEY TO OIL IN 2018
The direction of oil prices in 2018 will be decided in Texas. Crude oil production out of the U.S. is expected to hit record levels next year, buoyed in part by OPEC supply curbs that have put a floor under prices. Bloomberg News reports that for analysts forecasting prices next year, there are two key questions: exactly how far American production grows and whether the global economy is strong enough to swallow those extra barrels? Brent crude is expected to average $60 a barrel in 2018, while its U.S. counterpart is seen at about $55 a barrel, based on the median estimate of 27 analysts surveyed by Bloomberg. That’s below where oil prices sit now -- near $63 a barrel for Brent and close to $57 for West Texas Intermediate. “A lot of the divergence that you’ll find between the analysts that do their balances really pertains to this U.S. production growth figure,” Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas in London, who forecasts Brent will average $55 a barrel in 2018, told Bloomberg News.

WHERE THE BULLS AREN'T
It seems that whenever President Donald Trump tweets about how the heady performance of the U.S. stock market is a reflection of confidence in him, there's no shortage of critics who point out that as well as equities in America have performed, they've lagged behind the rest of the world. That's mostly true, with one big exception: Europe. Despite the strong performance of the euro this year, the Stoxx Europe 600 Index has struggled, which was underscored Wednesday by its biggest decline since the start of the month. The benchmark has barely budged from early November levels, leaving its fourth-quarter advance at just 0.6 percent. With the S&P 500 Index gaining 6.4 percent since Sept. 30, U.S. stocks are set for their biggest end-of-year win over those in Europe since 1991, according to Bloomberg News' Blaise Robinson and Sofia Horta e Costa. Renewed appetite for bank stocks at the start of December failed to ignite the kind of risk-taking in Europe that has sent U.S. benchmarks to all-time highs. That's probably because of big selloffs in single stocks such as Steinhoff International, Hennes & Mauritz and Saga.

WHAT RUSSIA SANCTIONS?
There is one notable bond market bucking the global selloff. Russia government yields have fallen to their lowest since November 2013, before Vladimir Putin ordered the invasion of Crimea. Ten-year yields slid three basis points to 7.46 percent Wednesday, and are poised for a third straight annual decline. A central bank committed to monetary easing is helping to bring down borrowing costs, while the slowest annual consumer-price inflation in the post-Soviet era is protecting investors’ real returns, according to Bloomberg News' Srinivasan Sivabalan. Bond yields have more than halved since the Bank of Russia resorted to an emergency interest-rate hike in December 2014 to contain the fallout from international sanctions and a plunge in crude-oil prices. This year, ruble bonds have posted the third-best performance among emerging markets in dollar terms, according to data compiled by Bloomberg.

TEA LEAVES
In a few hours the Bank of Japan will make an announcement regarding monetary policy. Although no change in interest rates is forecast, as is typical with central bank meetings economists and investors will be closing listening to what policy makers have to say about the outlook. With the BOJ, the focus will be on whether it hints at policy change for 2018 and whether Governor Haruhiko Kuroda drops any hints about the likelihood he will stay on in that role after his term ends in April, according to Bloomberg News' Toru Fujioka. Investors will be watching the general tone of Kuroda’s remarks for signs of improvement in the inflationary environment and how far away the BOJ sees its 2 percent price target.

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