Earlier in the week I commented President Trump controls the trade news cycle, writing all he has to do is tweet and immediately change the narrative.  Yesterday markets were going to open on their back foot until the President sent a tweet about an upcoming phone call with China to discuss trade.  Markets surged about 2%.

To write the obvious the markets are entirely controlled by algorithmic trading, technology based trading that responds primarily to five word headlines.  Many iconic luminaries have commented about the dysfunctionalism of market mechanics, mechanics based entirely upon momentum not value.  The SEC recently commented over 65% of volume is the result of algorithmic trading.  Wow!

Speaking about momentum, the Argentinian stock market fell 48% Monday and is down about 55% in a manner of 3 days.  The 100 year Argentina sovereign bond has plummeted from 98 late last week to around 49 yesterday.  Is this rational?  As widely noted this turmoil is the result of an unexpected electoral outcome in the presidential primaries.

Speaking of rational, at one time the yield curve was sacrosanct. Can I suggest because of monetary policy, the relevance of the yield curve may become discounted?  In years past there were several other “fail safe indicators.”

For example, 25 years ago all were myopically focused on M-2…aka money supply.  I vividly recall the hard and fast rule three consecutive months of a decline in the Index of Leading Economic Indicators is suggesting a recession is all but imminent.  And then there is the Phillips Curve.  High unemployment dictates low interest rates and vice versa.

I rhetorically ask who follows, much less aware, of the past significance of the above fail safe indicators?

I believe the central bank intervention has altered the short term significance of the yield curve.  The dramatic rally in the 10 and 30 year US Treasury is unprecedented for the economy that is still regarded as “robust,” with only fears of a slowdown.  The Treasury market is suggesting a pronounced recession in the immediacy.

Less than two weeks ago FRB Chair Powell said he did not see the central bank’s first interest rate cut since 2008 as the start of an extended easing cycle,  Today the bond market is suggesting three cuts by year end and four reductions next year.

There is a growing list of those who think US Treasury yields also can go negative.

Most extrapolate the current into infinity.  I continue to believe it is not if there will be a reversal in rates but rather when. The catalyst is not yet known but I continue to believe the economy will remain “robust” and inflationary pressures will continue to rise.  Yesterday’s data offered evidence supporting this position as small business optimism rose to the greatest level since November and the core CPI posted its greatest gain in a year, also rising more than expected.

Yesterday I commented about the dearth of liquidity.  JP Morgan validated this view when it wrote Tuesday “A familiar bogeyman is lurking alongside the gut wrenching swings across assets of all strips:  illiquidity.  It is very problematic even by the dire standards of August.”

The Bank stated measures of market depth have fallen sharply below the average since 2010 “leaving diminished capacity to absorb the trade driven mania sweeping assets.”

Speaking of diminished capacity, oil surged yesterday by the greatest amount since January.  Oil is regarded the most liquid of all commodities but the recent volatility suggests both a bullish and bearish mania.  The vast preponderance of oil trading is conducted via technology.

What will happen today?

Last night the foreign markets were mixed.  London was down 0.96%, Paris down 1.39%  and Frankfurt down 1.51%.  China was up 0.69%,  Japan up 0.98%,  and Hang Sang up 0.08%.

The Dow should open moderately lower on economic concerns.  The yield curve between the two year and ten year has inverted for the first time since 2007.  To remind all, the yield curve was inverted for the longest period in history and at times the inversion was the sharpest in history.  I am certain the narrative will rise exponentially about today’s inversion but I rhetorically ask are there other factors involved.  For example the massive and unprecedented flooding of the financial system via QE?

The 10-year is up 1/ 32 to yield 1.59%.  The 30 year is at a record low yield of 2.03%, up over 3 points.  Wow!


The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.