Pause for Thought; Stocks Make Up Some Ground Ahead of Big Central Bank Week

Escalation 

Stuff is happening in the Middle East – fighting continues, not sure if it is going to escalate – markets not showing a huge degree of stress this morning: dollar steady, oil down within the range of the last week, gold pulling back from Friday’s nudge above $2k, 10yr Treasury yield closer to 4.8% than 5% this morning, equities firmer with the FTSE 100 adding three-quarters of a percent and the DAX up more than half a percent in early trading. 

In the Market Today 

Equities trade a bit higher this morning after a bruising month. The S&P 500 dipped into correction territory – down almost 2.5% last week and more than 10% below its record high. It’s down 4% for October and on track for a third straight monthly decline. Major European indices are down 3-4% for the month so far. Asian indices trade about 2-4% lower. Jamie Dimon is selling JPM stock for the first time – tin hats time! Morgan Stanley’s Mike Wilson – for it is he – thinks chances of a year-end rally are diminishing (he would say this…). He writes: 

“Our observations on narrowing breadth, cautious factor leadership, falling earnings revisions and fading consumer and business confidence tell a different story than the consensus, which sees a rally into year-end that’s based mostly on bearish sentiment and seasonal tendencies.” 

 For the H4L camp – UoM inflation expectations were notably higher on Friday. Year-ahead inflation expectations rose from 3.2% last month to 4.2% this month, the highest reading since May 2023. Long-run inflation expectations edged up from 2.8% last month to 3.0%. In Europe meanwhile German inflation data is streaming into today – I note that North Rhine Westphalia inflation came in soft…bar for another hike rising all the time. ECB Governing Council member Boris Vujcic said over the weekend: “We have finished with the process of raising interest rates for now.” 

Pause for thought, or the worm turns?  

This week we will see who’s going to blink: The Bank of Canada and European Central Bank left rates unchanged last week and the focus shifts to when to cut. The ECB is now seen cutting perhaps in April – for me this looks a little ambitious on the part of the doves and ignores the central higher for longer mantra. Governing Council member Kazimir this morning says “bets on rate cuts happening in 1H 2024 are entirely misplaced”. EURUSD has failed to move from the 1.0550 area it traded before the ECB decision last week...markets looking for something else in the pair and they will get it this week with some major central bank decisions and key data.  

The Fed is a slam dunk to leave rates unchanged at this week’s FOMC meeting. Though it left the door open for another hike this year, markets have firmly priced out the chance that this will take place at its Oct 31-Nov 1st meeting. There seems to be a bit of uncertainty around Q4 growth and inflation trends remain encouraging – the Fed has already signalled it’s more about how long it leaves rates this restrictive than worrying too much about another hike.  So, the question reverts to ‘when cut?’. The Fed is now seen cutting by June...again this looks to be a trifle optimistic. The data would need to see a big deceleration from here to make that probable. The thumping Q3 GDP print is backwards looking but still shows the underlying fizziness in the economy. Bears will be keen to point out the similarities with 2007’s advanced Q4 GDP reading, which also came in at +4.9%. History doesn’t rhyme, it repeats!   

Meanwhile the Bank of England is expected to leave rates on hold at 5.25% again and signal it’s done with tightening for now. It paused the 2-yr hiking cycle in September and there seems little to recommend changing course for now. It’s scaled Table Mountain and is happy to enjoy the view before descending the cable car. Three hawks who voted for rates to rise last time to 5.5% may still vote this way – and it would be likely that the MPC would reiterate forward guidance suggesting it could raise rates again if required. Although inflation held firm at 6.7% in September, no fireworks are expected from the Monetary Policy Committee at the November meeting. Signs of labour market weakness and softening growth outlook will stay the hand of the MPC. The unemployment rate rose to 4.2% between June and August, up from 4% in the March-to-May quarter, whilst signs of a slowdown in the economy seem to be building. As per the Fed, it’s now a case of how long does the BoE keep rates at these levels rather than how high do they go. With the Bank of England seen holding the 2yr gilt yield is down to 4.707%, lowest since June   

Non-Farms  

The nonfarm payrolls report is the big-ticket item for the USD on Friday – remember the duration for rates to stay as restrictive is dependent on the labour market. A month ago, the jobs report came in at +336k vs 170k expected – 33rd month of jobs gains and revisions turned higher after multiple months of downward revisions. Revisions added 119k to July and August. Wage growth was the softest monthly increase since Feb ‘22 and smallest year-over-year gain since June 2021 – good news for the Fed. Since then, few signs of cracks have emerged with weekly unemployment claims hovering at nine-month lows. JOLTS job openings are due on Wednesday – these were a good indicator for the NFP last time. 

Bond Yield Pressure 

Surging global bond yields continue to heap pressure on the Bank of Japan to adjust its ultra-loose monetary policy. The 10yr JGB struck its highest level in a decade last week, forcing the BoJ into more unscheduled bond-buying operations, whilst the yen has weakened past 150. It sits just below this level this morning. Whilst it may refrain from making any formal adjustment to its yield curve control policy, it may be minded to signal it’s closer to widening the 1% cap. The bar for action is lowering – the move in yields suggests market participants are anticipating something. BofA Global says the Bank of Japan may raise its ceiling for yield curve control to 1.5% this week.  It could also lift the 10yr JGB target a touch from 0% to 0.5% perhaps; but signaling normalization rather than doing it may ultimately be preferred. The BoJ has repeatedly said it will maintain ultra-loose policy until inflation hits 2% on a sustainable basis and its own latest reading – the weighted median y/y reading – rose to 2% in September from 1.8% in August. And on Friday the closely watched Tokyo core inflation gauge unexpectedly rose. This week the BoJ will surely raise its CPI inflation outlook for the 2024 fiscal year, implying it’s close to pulling the trigger. Currently this is projected at 1.9%. Governor Ueda has previously signaled the BoJ could end negative rates when the 2% target is in sight. The blinkers are on but surely even the BoJ will need to acknowledge it’s time to act. Will this spur the BoJ into action? Maybe not this week but if the central bank revises up its inflation forecasts the market may assume YCC changes and an end to negative rates are just around the corner. The BoJ either has to be hawkish or sound hawkish.