Equity markets had a strong rally last week, accompanied by a notable decline in bond yields. The S&P 500 index surged by 5.9%
The Treasury selloff has been the primary cause for the vapid selling tilt in equities since August, so with bonds in rally mode, equities were cleared for launch.
The recent deluge of economic data does not paint a picture of an impending recession; most economic indicators, aside from a notable miss in the ISM manufacturing index, did not signal a recession. Instead, the data seemed to align with a "just right" scenario, akin to Goldilocks.
Indeed, a string of “just right” US macroeconomic data and a well-balanced message from the Federal Open Market Committee (FOMC) have reignited hopes for the best possible scenario for the world's largest economy.
The non-farm payrolls (NFP) headline and the ADP employment report indicated that the US economy is still generating jobs at a robust pace. The deceleration in job growth observed in the numbers was seen as hitting the right note. It mitigated the risk of overheating or an excessively rapid economic expansion, a key factor holding the Federal Reserve back from officially declaring that it has reached its terminal rate. This adjustment in economic activity was viewed positively, even if not all market participants would necessarily agree.
Market sentiment has increasingly aligned with the belief that the Federal Reserve has completed its rate hiking cycle. This expectation shift has led to a significant reduction in the rate hike premium for the December and January meetings.
Still, Jay Powell and the company are likely to be uneasy with the market pricing out and bringing forward rate cuts, especially when there are already indications of a robust cross-asset rally that's easing financial conditions.
However, the risks associated with inflation from a revived wealth effect appear to be less concerning now compared to August 2022. Back then, Jerome Powell had to push back during the Jackson Hole symposium as the market was eager to price in less aggressive monetary policy, even though headline inflation was still well above the central bank's target.
In the week, MXCN/CSI300 saw a modest increase of 0.9% and 0.6%, respectively, after President Xi chaired the Central Financial Work Conference from October 30 to 31, a critical event held once every five years, which focused on comprehensive financial supervision, supporting the real economy, and risk prevention.
On the international front, the US announced that President Biden is expected to have a "constructive meeting" with President Xi during the APEC summit in San Francisco, scheduled for November 15-17.
Financial markets experienced some fluctuations, with the overnight repo rate spiking to as high as 50% on October 31. Southbound investments saw notable US$1.1 billion significant bottom-picking inflows as global equity markets were in launch mode as global financial conditions eased with US yields coming off the boil.
Economic data showed mixed results as both NBS's and Caixin's PMIs were below expectations in October. Additionally, Q3 2023 Balance of Payments (BOP) data indicated a trend of faster capital outflows, providing the ultimate poor eye candy.
UST yields saw a significant decline throughout the week; notably, the benchmark 10-year yield, within 5 basis points of its recent peak at the close of the prior Tuesday, has now retreated by more than 40 basis points. It sure looks like bonds were oversold, and many speculators turned bag holders as yields approached the upper bounds of their new range.
Several factors contributed to this reversal.
First and foremost, the outcome of the refunding meeting indicated that the supply of longer-duration bonds would be more limited than many investors had anticipated. Even some very cagy Wall Street bond shops overestimated the influence of supply on market-clearing levels, mainly due to the absence of price-agnostic buyers who were supposedly replaced with price-sensitive marginal investors. Indeed, this setup resulted in heightened volatility in longer-term bond yields in response to subtle shifts in the macroeconomic landscape rather than a simple grind higher on yields.
Second, despite the robust economic momentum observed in the prior month, recent macroeconomic data exhibited signs of cooling, with both ISM reports and the labour market report falling short of expectations.
Third, it certainly looks like a significant degree of short positioning within the speculative community, particularly at the longer end of the yield curve.
The magnitude of market moves, both on the ascent and the recent descent, has been viciously magnified compared to the size of information surprises. I mean, a 50 bp drop on a smaller auction, marginally weaker economic data, and a Fed on hold at + 5 %
The FOMC meeting was marginally dovish but important for FX traders; Chairman Powell signalled that the Fed doesn't perceive an immediate need to raise rates solely based on robust economic data. So, if the Fed is not going to hike on solid data and inflation is sliding down the mountain, this helps explain why the dollar sold post-FOMC
Now that we have distanced ourselves from yen insanity top side calls, I expect some calls to flip to Yen insanity downside calls.
However, the BoJ’s gradual approach to policy is relatively minor and won't significantly strengthen the yen. With the US economic outlook still appearing on solid ground and the potential for high US yields to remain higher for a while longer, the yen is not expected to strengthen too much over the short term. While there may be some bumps along the road, like the risk of intervention and possible yield relief driven by softer US data, significant yen strength is unlikely without a substantial hiking cycle from the BoJ, cuts from the Fed, or a US recession.
Hezbollah leader Hassan Nasrallah on Friday stated that his organization has no intention of launching a full-scale war against Israel. Instead, they plan to keep the Israeli Defense Forces occupied in the north to reduce the burden on Hamas in Gaza. This announcement hurt the crude oil market, as an increase in Hezbollah's engagement could lead to state-on-state conflicts with Iran and cause supply disruptions. However, oil prices have yet to react significantly to this conflict, at least not yet.
A US election year
Yes, the 2024 US presidential election is anticipated to be an event of significant importance and public interest, much like the 2020 election. As of now, it appears likely that the major candidates will be the same as in the previous election, with the potential for a rematch between Donald Trump and Joe Biden. This anticipation is based on prediction markets and current political dynamics, which suggest that these two prominent figures may be the key contenders once again. As such, the 2024 election is expected to draw significant attention and be closely watched by both domestic and international audiences.
Donald Trump has indeed faced legal challenges and investigations, including criminal indictments. However, Trump's legal issues have not necessarily been a significant obstacle to his political career. In some cases, his supporters have remained loyal, and some even see these legal challenges as proof of his outsider status and resistance to the establishment.
Additionally, the dynamics of the Republican primary field can play a significant role. Suppose Trump is the dominant and favoured candidate within the Republican Party. In that case, he may not feel the need to participate in primary debates and barring some legal twist that prevents him from seeking the presidency, he’s effectively running as an incumbent.
Democrats probably should run someone other than Biden, but it’s not obvious who that person would be. America is not enamoured with Kamala Harris. Democrats are afraid of another Trump presidency and are not willing to take risks. It is debatable whether Biden is a riskless candidate, but as an outsider looking in that is not for me to adjudicate.
It's important to consider the potential impact of another Trump presidency or candidacy on the rule of law in America and the country's creditworthiness. This topic will be discussed frequently throughout the year and is of particular concern for the bond market.
It's interesting to note that equities historically tend to underperform during the 12 months leading up to a presidential election when compared to other years in the economic cycle. The S&P 500 has shown an average return of 7% in the 12 months before an election, while it has returned an average of 9% in non-election years since 1932. This underperformance is more pronounced in recent history, with an average return of just 4% in the 12 months before the 10 presidential elections since 1984, to paraphrase David Kostin’s latest.
It's a valid point to consider the impact of significant market turmoil in 2000, 2008, and 2020 on the historical data. When excluding those years, the average return of US equities during presidential election periods since 1984 increases to 9%, compared to 11% in non-election years. This adjustment helps provide a more nuanced perspective on the relationship between election cycles and market performance.
One caveat: Goldman Sachs' assessment of a 15% chance of a recession occurring between now and the 2024 presidential election reflects their economic outlook, which is less pessimistic compared to the coin toss median forecast among various other Wall Street analysts
Donald Trump's political and personal circumstances make this election cycle unlike any other. His unique position as a former president and the various allegations and controversies surrounding him indeed introduce unprecedented variables and uncertainties into the political and economic landscape. The outcome of the 2024 election, the tone of the campaign, and the potential implications for governance and policy will be closely watched by both domestic and international observers. This unpredictability adds to the complexity of assessing the potential impact of the election on markets and the broader economy.
Despite the lowest unemployment rate in the country and red-hot GDP growth, President Biden's approval ratings are very poor, which is unusual. The reason behind this is no mystery - people don't like inflation. However, it's important to note that America hasn't been as divided as it is in 2023 since the Civil War. The intense partisan rancour means that polls are hopelessly skewed, and people's opinions don't reflect their actual views on economic outcomes and policy choices but rather their party affiliation. Republicans will always criticize Biden's management of the economy, regardless of whether inflation is at 2% or lower. Similarly, if Trump were to be re-elected, Democrats would criticize the economy even if it had 5% growth and 2% inflation.
Trying to predict the economic cycle coming out of the pandemic is risky due to its anomalous nature. Generalizing past experiences is not advisable. Forecasting macro outcomes has always been a difficult task, but now it’s hopeless to the point of being a fool’s errand as if you haven’t noticed.
Finally, the geopolitical landscape is a minefield. The current geopolitical situation is highly volatile and uncertain, which poses significant risks not only figuratively but also literally. There is a possibility, albeit unlikely, that the United States could become involved in a major conflict with a formidable opponent, such as Russia, Iran, or even the apocalypse scenario, China, within the next year. That would have all manner of ramifications for the campaign, even if stocks tend to be indifferent, as they often are.
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