The Daily Prophet: Risk-On Doesn't Get Much Better Than This

Connecting the dots in global markets.

Monday was one of those rare days when everything seemed to be a winner. Global stocks rallied, government bonds rose, commodities jumped and emerging markets climbed. Heck, even the Bloomberg Dollar Spot Index managed to eke out a small gain.

In many ways, it feels like a return to the heady days of late 2017, except without all the warnings about "complacency." Markets know that the Federal Reserve will look for any excuse to continue to raise interest rates, it's the pace that matters. When the year started, markets expected two increases, but when the recent inflation data came in higher than forecast, investors seemed to skip three and started to talk about the possibility of four rate hikes. Fed officials have made comments in the last week that have alleviated some of the market's concerns, and traders are betting that Jerome Powell will have little incentive to shock markets with overly hawkish comments when he provides his first congressional testimony as Fed chairman on Tuesday.

Powell's "plan is to calm the markets in terms of stepping away from four" rate increases this year, Paul Richards, president of Medley Global Advisors, said on Bloomberg TV. "If he can succeed in doing that tomorrow, and I think he will, I think the market is going to be quite pro risk." If that's the case, then we may see the beginnings of the "Powell put."

Goldman Sachs created a stir when one of its economists, Daan Struyven, wrote in a research note Saturday that stocks would fall 20 percent to 25 percent if the yield on the benchmark3 10-year Treasury rose to 4.5 percent by year-end. Although that may seem like it's time to do some handwringing, the good news is that almost nobody sees yields reaching such levels anytime soon. The median estimate in a Bloomberg News survey of 60 economists and strategists is for the yield to end the year at 3 percent. That's not far from the note's 2.86 percent yield on Monday. Goldman Sachs itself says the base-case scenario is for a yield of 3.25 percent at year-end, according to Bloomberg News' Joanna Ossinger. The economic data has softened somewhat this month, and traders are taking a bit of a break from their bearish bets after watching yields rise from less than 2.05 percent in early September. Hedge funds and other large speculators cut their short position in Treasury 10-year futures by 59,575 contracts in the latest week, the steepest reduction since November, to 896,019 contracts, according to Bloomberg News' Brian Chappatta, citing Commodity Futures Trading Commission data through Feb. 20.

The narrative in the U.S. housing market has been that low levels of inventory have helped suppress sales while boosting prices.  That may be changing based on the latest data. Government data released Monday showed that sales of new homes unexpectedly fell 7.8 percent in January. That followed a decline of 7.6 percent in December. Not since the first two months of 2007 have sales had back-to-back declines of more than 7 percent. What may be just as concerning is that the supply of homes at current sales rate climbed to 6.1 months from 5.5 months, the highest since July 2014. There were 301,000 new houses on the market at end of January, the most since March 2009. Yes, January can be a volatile month because of the weather, but it looks like the higher borrowing costs brought on by the selloff in the bond market may be starting to bite. Freddie Mac said Thursday that the average rate on a 30-year mortgage has jumped to 4.40 percent, from 3.78 percent in September. Investors don't seem confident things will turn around. The 13-member Bloomberg America's Home Builders Index has fallen 9.3 percent since rate jitters began to surface in early December, compared with a gain of 4.98 percent for the S&P 500 Index.

While political scientists debate the meaning of Xi Jinping's decision to cast aside China’s presidential term limits, markets like what they see. The Shanghai Composite Index rallied to a three-week high and government bonds gained, with 10-year yields falling to the lowest in four months. The yuan climbed 0.5 percent against the dollar. Although the potential for the absence of checks and balances raises the risk of policy errors,  political certainty should be largely positive for Chinese assets as it bolsters the Xi's ability to drive through policies, such as those related to the deleveraging, according to Bloomberg News' Justina Lee. “China is still only half-way through reforms and economic transformation, so policy continuity is very important,” Banny Lam, head of research at CEB International Investment Corp. in Hong Kong, told Bloomberg News. Lee reports that Xi’s term since 2013 has been marked by a mostly steady economy but also periods of volatility in the financial markets, typically triggering government intervention to prop up financial assets. Maybe that's what investors really like. "While most of the stories on this have focused on growing authoritarian tendencies in China, there is another way to view this -- and that is on China’s ability to get things done," Robert Carnell, the chief economist and head of research for Asia-Pacific at ING Bank, wrote in a research note.

Treasury Secretary Steven Mnuchin said Friday that the U.S. will be imposing new sanctions on Russia within weeks. Nevertheless, that didn’t stop S&P Global Ratings from raising its assessment of the world’s biggest energy exporter to investment grade. The result was that the ruble closed at its highest level since April, the nation's stocks headed for a record high and its eurobond yields fell. Now that the country has a non-speculative ranking from two of the three main ratings firms, more conservative investors such as pension funds and insurance companies will be able to invest in its debt, Finance Minister Anton Siluanov said over the weekend. Russia has one of the lowest debt levels in emerging markets and the premium investors demand to hold its Eurobonds instead of U.S. Treasuries has almost halved in the past year as oil recovered and investors hunted for higher returns in emerging markets, according to Bloomberg News' Alex Nicholson. The upgrade is also significant for other reasons: it comes just three weeks before the presidential election and marks a rare vote of approval from an international organization even as Russia’s relations with the U.S. and Europe are at a post-Soviet low.

Powell takes center stage Tuesday, testifying to Congress on the state of the economy for the first time as chairman of the Fed. As a Fed governor, Powell’s commentary on the U.S. economic outlook was often sparse and closely aligned with the central view on the Federal Open Market Committee, according to the economists at Bloomberg Intelligence. They say the hearing will be closely parsed for any divergence from the economic assessments and policy approaches of the Janet Yellen-era FOMC. They note that sentiment at the Fed of late appears to be drifting toward a firmer pace of rate normalization in outlying years. Given the market’s obsession with inflation, his musings on this topic will probably be most closely scrutinized. Tom Porcelli, the chief U.S. economist at RBC Capital Markets, noted that in his November confirmation hearing, Powell pointed out that the FOMC was still largely looking for confirmation as to whether the early to mid-2017 slowdown in inflation was indeed transitory. Porcelli says Powell is unlikely to sound as uncertain as he did in November given the run-up in oil prices, weakness in the dollar, and gains in the latest data.

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