U.S. Yield curve recession

Market Wrap 01/09/2019

By: Victor Yan


Equities

Amidst a season saturated with the US and China trade war narrative, equity indices have continued their volatile profile this week. Following last Friday’s bearish turn after a response by China to impose tariffs worth $75 billion of U.S. goods, Monday saw the S&P 500 fall from an open of 2910.27 to close the day at 2905.67. To add insult to injury, Trump further declared an intention to further hike existing tariffs to a further $250 billion in Chinese goods, as well as a new round on $300 billion in goods to be taxed at 15%.

While such news can demonstrably result in a harsh downside reaction by the market, the week ended on an optimistic note as US equities surged after renewed hopes for trade negotiations between the two global behemoths – as cited by Trump’s testament towards the US and China having conducted further trade talks this Thursday. The S&P 500 closed Friday at 2954.58, its first weekly gain over the last 5 weeks.

With China and the US seemingly playing a twisted “Jekyll and Hyde” game of trade negotiations, Australia’s economy has been caught within the trade wars’ financial crossfires. The ASX 200’s weekly progress saw a similar profile of sharp falls to start the week before a strong resurgence back to close the week at 6604.20, an overall weekly profit for equity holders. Yet, Augusts’ final week suggests mere consolation when taken into context of the month – of which had opened the month off at 6812.60, implying a -1.03% drop in returns for the market.

Commodities

During times of economic uncertainty, we often see a transfer of wealth towards “safe-haven” assets as a means of sheltering the financial storms of the market. For one, Gold has surged this week due to the aforementioned trade war concerns and signals towards a US recession via persistent yield curve inversions, as the precious metal became slightly more so with a push up to 1556 to start the week – its highest mark since April 2013. This weekly close has capped off a very successful August for those long Gold – with its highest monthly gain since early 2012.

Crude oil had also experienced a big boost this week – primarily fuelled by API reports of a fall of 11.1 million barrels in US inventories (the largest stock draw since June). This vastly outpaced market expectations of a 2.85 million barrel draw, where depleted supply saw roughly a $3 gain in the commodity from $53 to $56.

Forex

The British Pound saw a decline of 0.6% against the greenback following reports of PM Boris Johnson’s intentions to suspend UK Parliament from September to October 14th– reigniting Brexit fears as such actions may hinder Parliaments’ ability to prevent a “no Brexit” deal. Pound to USD implied volatility (an indicator towards the market’s perception of a UK-EU future without a Brexit deal) spiked to 13.09% – its highest reading since former PM May’s cancellation of Parliament’s original Brexit vote back in December 2018.

The Argentina peso slid after president Macri asked creditors for an extension to repay its $101 billion debt bill – looking to reprofile their debt maturities with the IMF towards a longer-term horizon. However, amplified reactions towards concerns over a nation default led to market selloffs of the currency – as the market saw such extension requests as a move as merely delaying the inevitable. Now trading at 57.95 per US dollar, the peso has lost over 22% of its value since mid-August.

Bonds

One of the financial market’s current hot topics has been surrounding the current inversion of bond yields – of which most see as a general indicator of an upcoming recession. While US bond yields surged slightly higher following renewed trade talks, this was merely following 30-year Treasury bond yields hitting all-time lows on Wednesday, with the 30-year yield now below its 3-month counterpart.

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Environmental Sector

LGCs (Large-Scale Generation Certificates) are a common financial instrument within the Australian renewable energy market, where each LGC is representative of 1 MWh of net renewable energy generated and exported to the electric grid via a solar PV system over 100 kW in load. While they are typically used as an incentive scheme towards retail and institutional adoption of solar systems, they are also viable instruments to be traded on the market.

LGCs are forecasted in the long term to run a backwardation trend due to future expected gluts for the instrument. Yet, the past few months have seen a short run increase in LGC pricing both in spot and futures. This was largely due to reduced oversupply results for LGCs following 7 million LGCs being carried forward from 2018 as part of an under surrender – with its impacts being realised into the Cal 19, or as of now – the spot contracts. Thus, we have seen a prominent uptick in Spot, Cal 20 and Cal 21 LGC contracts to prices of $46.40, $47.00 and $27.00 respectively.

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Sources: Bloomberg, Reuters, Marketwatch, SMH

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