Market sentiment and the Fed's tightening cycle: Is the market getting ahead of itself?

Markets

The new trading week yesterday started with a countermove on last week’s overall easing in financial conditions. Maybe the market has been running a bit ahead of itself in declaring an end to the Fed’s tightening cycle or at least it was too early to pencil in rate cuts before the summer of next year. Contrary to what was the case last week, there was little economic news to ‘explain’ the move. Technical levels probably played a role, with US yields end last week testing key support levels (e.g. 4.50% for the 10-y). Upcoming supply maybe also was a good reason for investors to turn more cautious to further rush into bonds (US Treasury refinancing starting today). Whatever the driver, US yields yesterday rebounded between 9.6 bps (2-y) and 4.2 bps (30-y). At 4.635%, the 10-y US yield again created some breathing space compared to the 4.50% reference. Overnight, Minneapolis Fed governor Kashkari joined yesterday’s market mood as he warned that it’s too soon to declare victory on inflation. More data are needed to be sure that ‘the inflation genie’ is back in the bottle, he assessed. EMU/German yields followed the broader rise but as was the case on Friday, the curve move again was a bit different from the US (bear steepening, 2-y +6.2 bps; 10-y +9.4 bps). ECB’s Holzmann, admittedly a notable hawk, came with a similar conclusion as did Kashkari (not declaring victory yet). Doubts on the room for early (Fed) easing also blocked that rebound in equities. US indices finished with limited gains (Dow +0.1%, Nasdaq +0.3%). First key resistance levels (Dow 34148, S&P 4394, Nasdaq 13714) are under test or within reach, but not recovered yet. This also applies for the Eurostoxx50 (+0.38%, ST top at 4.234). Oil ($ 85 p/b) hardly gained even as Russia and Saudi Arabia extended production cuts. The dollar halted Friday’s sell-off, but its performance remained unconvincing (DXY 105.21 from 105.02, EUR/USD 1.0718 from 1.073). Sterling underperformed both the dollar (cable close 1.2344) and the euro (EUR/GBP close 0.8682).

This morning, Asian markets return to risk-off mode. China October trade data show a mixed picture exports (USD -6.4% Y/Y) disappointed. Imports rose more than expected (+6.4%Y/Y). US Treasuries gain marginally as does the dollar (DXY 105.4). Later today, eco data (US trade balance, German production) probably won’t have a lasting impact on trading. Interest rate markets will keep a close eye at the $ 48 bln sale of 3-y Treasury Notes. Still, technical trading might again prevail. On interest rate markets, yesterday’s price action suggests that a sustained decline below last week’s lows won’t be that evident. On FX markets we look out whether the dollar will be able to profit more from a global risk-off than was the case of late. Sterling (EUR/GBP 0.868) this morning hardly reacts to mediocre BRC October retail sales (+2.5% Y/Y from 2.8%)

News and views

The Reserve Bank of Australia hiked its policy rate by 25 bps to 4.35%, interrupting a four-meeting pause during which it judged that higher interest rates were balancing the economy and that some tightening impact was yet to be felt. Today, however, it concluded that the progress in CPI declining towards target is slower than in the August forecasts expected. The latest reading “indicates that while goods price inflation has eased further, the prices of many services are continuing to rise briskly.” Inflation is seen at around 3.5% by end 2024 and at the top of the 2-3% target by end 2025. The risk of inflation (expectations) being higher for longer against the background of a stronger than expected economy and still tight labour market thus warranted another rate increase. The RBA said uncertainties around the outlook are significant and often two-sided. Further tightening in such circumstances will depend upon the data and the evolving assessment of risks, it said. The Australian dollar’s attempt to rise on the not fully discounted rate hike was shortlived. After touching AUD/USD 0.65, the pair turned south to trade around 0.648 currently. Australian government bond yields ease 2.9-3.3 bps.

The Fed’s Q3 Senior Loan Officer Opinion Survey (SLOOS) yesterday showed how lending standards tightening across all kinds of loans. In the business segment, survey respondents reported tighter standards and weaker demand for commercial and industrial loans to firms of all sizes. Tighter standards and weaker demand also prevailed for all commercial real estate loan categories. Consumer lending tightened and demand weakened across all categories of residential real estate. The same applied for credit card, auto and other consumer loans.

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