Smart Money

Global markets had mixed returns for the month ending 22-Mar-18. The TSX lead the way with a 1.6% gain spurred by commodities.  The S&P 500 index was up 0.5% while the MSCI fared worse with a 1.4% loss as Asian markets experienced weakness.  Korean automobile manufacturers were particularly impacted on trade war worries, while Japanese equities experienced Yen strength as a headwind during the month.  On the commodity front, Oil reversed a 2.5% slide to gain 5.1% on the back of strong inventory data, while gold strengthened by 1%.  As stock market volatility increased, the price of gold climbed.  Gold is notoriously known as a safety asset.  Accordingly, it tends to rise when there is a meaningful slump in the market. Investors often take shelter in non-yield-bearing gold as a buffer against risk.  The US 10-year Treasury Yield appreciated 5bps, bouncing back over 2.90%.

Trade wars have been a constant theme weighing on markets in 2018.  On 1-Mar-18, Trump announced a 25% tariff on steel imports and a 10% tariff on aluminum to help shore-up weakening domestic  industries.  Though Trump walked-back part of these measures as they relate to Canada and Mexico, pending final NAFTA negotiations, some have hinted at the move being a direct message to China.  Chinese steel production has been curtailed dramatically for environmental reasons.  This has contributed to steel exports into the US falling from 400K metric tons/month in 2014 to 60K.  However, many are looking beyond this announcement to potential follow-on effects, including the announcement of an estimated US$50Bn in tariffs against China over intellectual property violations.  The amount was based on estimates of economic damage caused by China through the theft of US technology and intellectual property. China has not yet made any counter-announcements, but they have hinted at retaliation.  China is not the only country affected by the tariffs either, as leaders from other countries such as those in Europe have also hinted at retaliatory measures.  Inflation, which has already shown signs of strength, is a notable consequence of trade wars.

We have previously commented on increased market liquidity (QE-driven) and its positive affect on markets.  With the Fed embarking on a QE unwind and potential impacts of USD repatriation starting to take hold, signs of USD shortages are beginning to show.  This can be seen in the US LIBOR-OIS spread, or the differential between the rate banks charge to each other to lend (LIBOR) vs. the overnight risk-free rate (OIS).  With the majority of loans priced off LIBOR, a rising rate may reveal reduced USD liquidity. In turn, the willingness for banks  to lend into the market may be diminished.  The 55bps spread hit on 21-Mar-18 reflects the highest spread seen since the Global Financial Crisis in 2007, which is material, though the cause can only be approximated.  Either way, it is something to monitor as any liquidity shortage could have pronounced implications on asset prices and credit risk/borrowing capacity in general.