Flight to safety meets a high earnings bar as central bank week begins

Preview: Treasuries rallied again, equities are struggling, and central banks and earnings are on the horizon.

The week that was: Bonds rally and stocks fall

Last week, US Treasuries rallied for a second consecutive week. This pushed 10s and 30s to 5% and 5.33%, respectively, flattening the curve even as Brent crude rallied about 7% to within striking distance of March peaks at US$119.50, and tech stocks posted a second straight week of losses. The US-led move in bond yields has exposed fragilities elsewhere. France is the clearest example, with its spread over German bunds at about 170 bps and Italian spreads widening in sympathy.

Interestingly, stocks did not struggle when yields were rising before, so why the drop now? I believe bond investors are entering the fray because they are worried about earnings and growth. Market participants continue to question the huge spending on the AI build-out, driving a classic flight to safety.

We are in a situation where good earnings are no longer enough. Q2 earnings were standout and set the bar high – 78% of S&P 500 companies beat EPS estimates. Consequently, Q3 earnings season needs to deliver. If they do, the recent selling across US indices may lay the groundwork for dip-buying; the risk, of course, is that they do not produce.

So far, the market response to Q3 earnings relative to Q2 has shifted dramatically, punishing even companies that clear their bars. While early results show that a solid majority of companies continue to report positive EPS surprises, Wall Street is operating with an unusually high hurdle.

The week that is: Central bank bonanza ahead and Aus CPI

The final full week of October is upon us, and it is a busy one. My focus will be on updates from the five major central banks – the RBNZ, BoC, Fed, ECB, and BoJ – the UK Autumn Budget, Australian inflation, and a stretch of Q3 earnings, with a whopping 36% of S&P 500 companies reporting. Alphabet, Microsoft, and Amazon make up roughly a quarter of the Nasdaq. I will be watching guidance and evidence that AI spending is generating returns.

Australian CPI inflation

The September Australian CPI data will air on Wednesday at 12:30 am GMT and is the first risk event to land. This is the last major inflation report before the RBA meets on 3 November, after raising the cash rate four times this year.

The trimmed-mean print is the one to watch here; markets expect Q3 to come in higher at 1.0% versus 0.8% prior (max/min estimate range between 1.0% and 0.9%), with YY Q3 expected to remain steady at 3.6% (max/min estimate range between 3.6% and 3.5%).

The RBA’s recent comments certainly lean more hawkish. Deputy Governor Andrew Hauser recently flagged higher-than-expected trimmed-mean inflation and tighter capacity, while Assistant Governor Christopher Kent questioned whether policy is restrictive enough.

Markets are pricing in about a 60% chance of an RBA hike on 3 November. An in-line CPI print should largely confirm this and be enough to lift the AUD, I feel, but a hotter number, say 1.1% QQ even if the YY remains at 3.6%, would likely lock in the hike and add fuel to an upside move. Positioning adds a twist: CFTC data shows the AUD is overstretched to the downside; therefore, a hawkish surprise could add to upside and trigger a short squeeze.

RBNZ rate decision

The RBNZ rate decision follows shortly after the Aussie CPI at 1:00 am GMT, and markets are fully pricing in a rate hike, which would raise the official cash rate (OCR) from 2.75% to 3.0%. Unless we see the central bank hold rates steady (very unlikely), the rate hike itself is unlikely to jolt the NZD much.

My issue is the gap between guidance and pricing. Including this week’s hike, investors are pricing in nearly 110 bps of tightening over the next year, implying an OCR of about 3.85%, whereas the RBNZ’s own projections peak at 3.3%.

The risk is a hawkish-versus-dovish tone surprise rather than a surprise on the decision itself. If the RBNZ comes out dovish, this could unwind some of the hawkish pricing. That said, any NZD selling could be short-lived, given how stretched the NZD is to the downside (CFTC positioning). A hawkish tone faces a similar issue; with so much already priced into the RBNZ, this could be a challenging NZD long.

With the Aussie CPI and RBNZ above, I will use Wednesday’s mailer to preview the day’s remaining event risk.