The United States narrowly avoided a potentially disruptive and costly shutdown of federal agencies as Congress passed compromise legislation to keep the government operational until November 17th. This bipartisan agreement grants Democrats and Republicans an extension to negotiate for longer-term federal funding. It's important to note that this legislation does not include additional funding for Ukraine.
With one of the potholes in Q4 economic growth seemingly filled temporarily, investors initially responded with a sense of relief during Monday's Asian market opening. However, there's a question looming about whether the market will interpret this good news for the economy as bad news for stocks.
As policymakers kick the can down the road, it might nudge yields slightly higher as markets shift their focus away from the negative economic implications of a government shutdown to the hawkish Fed.
Given the proximity of the new deadline to the holiday season, a resolution, at least in my view, appears more likely, as policymakers would likely want to avoid being seen as the " Grinches " that stole Chrismas by negatively impacting the lives of millions of government employees, even more so on the cusp of an election year and as labour activism rises in the US.
With the US government securing temporary funding to avoid a shutdown, the first week of October begins with a busy calendar, featuring data ranging from a new ISM Manufacturing survey to the September Payrolls report. Friday's jobs report could provide valuable insights into the future direction of US yields and stocks, assuming that interest rates remain a key focus for investors, as the report will significantly influence the Fed's response.
High US yields continue casting a shadow over US stocks, hinting at a lack of strong macro conviction and risk-taking in the market. As long as US yields remain elevated, the possibility of a significant holiday rally appears to be a pie in the sky at this point.
The Federal Reserve's preferred inflation measure fell short of expectations, strengthening the case for the Fed to hold off on raising interest rates in the current quarter, which should have been good news for risk markets. However, a significant upward revision in household savings offset this dovish interpretation, suggesting consumers might be more resilient than previously thought. As a result, the Fed's hawkish roadshow is expected to roll on, with all eyes on this week's Non-Farm Payrolls data.
Within this complex mix of highly nuanced data, there isn't a definitive signal of a significant drop in consumer spending that would indicate an impending slowdown, especially with the upward revision for July (revised to a 0.9% gain). However, there are emerging indications of stress as consumers contend with rising energy prices, increased borrowing costs, and decelerating income growth.
Following up on the NBS PMI, the Caixin China General Services Business Activity Index (headline services PMI) fell to 50.2 in September from 51.8 in August, disappointing consensus expectations for a slight increase. The NBS and the Caixin services PMI remained soft in September, potentially due to a fading reopening boost and weakening property market.
High rates and corporate America
Many companies took advantage of low rates in 2020 and 2021 to issue debt with longer maturities. They also used their substantial cash reserves to fund operations, shielding themselves from rising borrowing costs in 2022. This situation has allowed cash-rich corporations to benefit from higher rates. Whatever wasn't operationally deployed was reinvested at higher yields, contributing to resilient corporate treasury profits, thus improving large-cap bottom lines.
The impact of higher rates on corporations varies depending on their size. Large-cap companies with ample cash reserves are better insulated from the effects of rising rates, while small-cap companies are more vulnerable. However, as rates remain elevated, more firms will become exposed to the challenges posed by higher borrowing costs.
Despite the insulation provided by long-maturity, fixed-rate debt structures for S&P 500 companies, their borrowing costs have increased year-over-year, marking the most significant increase in nearly two decades. With many bonds rolling over, this suggests that even large companies are beginning to feel the impact of higher rates. The increase in interest expenses has been a significant headwind to aggregate return on equity (ROE). It has impacted every sector this year and may continue to do so until there is some significant rate relief.
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