Markets Price a Quicker Fed Pivot

For the week ending 17 November 2023

As of midday Friday, global equities rose as improved US inflation data reinforced the notion that the US Federal Reserve’s tightening cycle has ended. The yield on the US 10-year Treasury note declined 13 basis points from last Friday to 4.46% while the price of a barrel of West Texas Intermediate crude oil fell $1.50 to $75.25. Volatility, as measured by the Cboe Volatility Index (VIX), fell to 13.8 from 15 a week ago.

MACRO NEWS

Markets rally as US inflation declines

Consumer prices were unchanged from the month before and rose 3.2% year over year, down from 3.7% in October. The core rate, which excludes food and energy, rose 4% from a year ago, the lowest level since September 2021. Markets reacted jubilantly to the data with US 10-year Treasury yields falling around 20 basis points on the news and equities extending recent gains to more than 9% above the late-October lows as the odds of the US economy experiencing a soft landing increased. Investors abandoned bets that the Fed will hike one last time while pricing in early rate cuts. The chance of a rate cut in May jumped from 22% before the data to near 90% today. Contributing to the risk on market tone has been a significant loosening in financial conditions. In addition to higher stock prices and lower bond yields, the dollar weakened and credit spreads tightened. 

Xi and Biden meet 

Chinese President Xi Jinping and US President Joe Biden met on the sidelines of the APEC summit in San Francisco on Wednesday, their first face-to-face meeting in a year. The leaders agreed to resume military contacts, restart cooperation on choking off key ingredients for making fentanyl and open a dialogue on the risks posed by artificial intelligence. Xi told a group of American executives that he wants friendly relations with the US and has no interest in fighting either a cold or hot war. Attendees said they were surprised that Xi steered clear of discussing trade and investment. 

US Congress avoids budget drama

The US Congress passed a continuing resolution on Wednesday funding parts of the government through mid-January and other departments through early February. The bill contained no spending cuts nor did it include supplemental aid for Israel and Ukraine. Republican members of the House of Representatives allowed the bill to pass despite sizable opposition from within the GOP caucus rather than derailing newly-elected Speaker Mike Johnson’s first major piece of legislation. Without the legislation, which is expected to be signed by President Biden today, funding would have lapsed at midnight on Friday. 

QUICK HITS

Germany’s Constitutional Court ruled against the government’s transfer of COVID emergency funds to its Climate Fund. This effectively reduces Germany’s borrowing capacity by €60 billion, a short-term fiscal drag at a time when the economy is at stall speed.

Three Fed governors, including Vice Chair Philip Johnson, responded to a question from Senator Rick Scott (R, FL) saying that the size of the Fed’s balance sheet could decline considerably, but the ultimate size of the balance sheet will be determined by market demand for reserves and currency. 

Late last Friday, Moody’s cut its outlook on US government debt to negative from stable, citing deficits and political polarization. 

A Financial Times poll found that just 14% of Americans feel better off financially than when Biden took office, a headwind for his reelection prospects. 82% said price increases were their biggest source of financial stress. 

British Prime Minister Rishi Sunak reshuffled his cabinet this week, bringing former PM David Cameron back into the government as foreign secretary. 

In October, the inflation rate in the UK fell to a two-year low of 4.6% year over year from 6.7% in September.

China is considering providing at least ¥1 trillion ($137 billion) in new low-cost loans to shore up the struggling property market, Bloomberg reported this week. The People’s Bank of China would inject funds through policy banks in phases, with the money ultimately trickling down to households for home purchases, according to the report. 

Industrial production in the eurozone posted its seventh straight monthly decline in September, falling 1.1%. 

Sentiment among US homebuilders fell to the lowest levels since late 2022 when the Fed was raising rates in 0.75% increments. The Housing Market Index slipped to 34 in November from 40 in October. However, belying the gloomy outlook, housing starts and building permits ticked higher in October. 

The Bank of Japan continues to lay the ground work to exit its negative interest rate policy in early 2024 after a series of hawkish comments by Governor Kazuo Ueda. 

China’s home price decline deepened in October with residential property prices slumping 0.38% in October, the most in eight years. 

EARNINGS NEWS

With just under 95% of the constituents of the S&P 500 Index having reported for Q3 2023, blended earnings per share (which combines reported data with estimates for those that have yet to report) show that earnings rose 4.3% compared with the same quarter a year ago, according to data from FactSet. Sales growth is up 2.2% year over year.