Market Commentary: 15 October 2024
Markets Last Week
Economy
Economic data, particularly out of the US, has surprised to the upside in recent weeks, leading to notable moves in bond yields and a rotation into growth-oriented stocks at the expense of defensive sectors. Last week, recent US economic strength was compounded by rising US inflation, with September CPI inflation coming in hotter than economists had forecast. Annual core inflation, which strips out volatile food and energy prices, rose for the first time in 19 months.
The minutes from the September FOMC meeting released during the week highlighted that the decision to cut rates by 50bps was a close call. Confidence in the path of inflation has improved, and there were rising concerns about the labour market. The path of monetary policy is conditioned on the “evolution” of the economy and the balance of risks. The sticky inflation and exceptional September employment report since the FOMC meeting, reduces the downside risks to the economy suggesting that the Federal Reserve (Fed) may prefer to cut rates by 25bps at each of its two remaining meetings this year.
Equities
Earnings season got off to a strong start, pushing the US equity market to fresh all-time highs. Major banks reporting this week delivered better-than-expected results. Expectations for bank profitability in Q3 2024 were low due to reduced interest income and high deposit costs. The results exceeded expectations with banks reporting stronger-than-anticipated earnings, driven by surprisingly robust interest income, effective cost management and diversified revenue streams. This positive surprise led to a notable performance boost in the banking sector, contributing to overall market gains. Technology was the best-performing sector as growth outperformed value.
Outside of the US, market performance was more mixed; UK equities saw mild declines while Chinese and Hong Kong markets dropped more significantly as initial excitement around the China stimulus announcement faded.
Bonds
Bond yields continued to rise in October due to recent US economic strength and expectations of less aggressive central bank easing. The US Treasury curve ‘bear steepened,’ meaning long-term bond yields rose more than short-term yields. The yield curve, which had been inverted (short-term yields higher than long-term yields) for most of the last three years, normalised last month for the first time since May 2022. Last week, the yield curve briefly inverted again on Monday before steepening over the rest of the week, ending with a positive slope and a 2s10s spread (the difference between 2 and 10-year yields) of 0.14%.
This clear rejection of inversion reinforces the case for a steeper curve under two core economic scenarios. The first scenario is if the economy slows, leading to a bullish steepening (short-dated yields falling more than long-dated) as investors anticipate interest rate cuts. The second scenario involves higher growth and inflation, where longer-dated bonds are negatively impacted, resulting in a bear steepening similar to the pattern seen last week. The US 10-year yield rose 13bps to close at 4.1%, while the UK 10-year yield sits marginally higher at 4.2%.
The Week Ahead
Wednesday: UK CPI
Our thoughts: Headline inflation for September is expected to have slowed to 1.9%, undershooting the Bank of England’s (BoE) target. Services inflation is expected to slow quite significantly from 5.6% to 5.2% thanks to abating price pressure within airfares and accommodation. This should support another rate cut in the BoE’s November meeting.
Thursday: ECB rate decision
Our thoughts: With inflation below the bank’s target and risks tilted to the demand side the case for further policy easing has accelerated since the previous meeting. The swap market is pricing in a 96% probability that the ECB will cut interest rates on Thursday with a second cut expected in December.
Friday: China GDP
Our thoughts: Economic growth in the third quarter is expected to have slowed to 4.5% underscoring the need for Beijing to implement their recent stimulus package.