What a difference a week can make to sentiment. I think even without the encouraging noises from central banks, markets were probably due a bounce, but not to the extent they took off after we heard from the Fed. The S&P 500 had its best week of the year, rising nearly 6%, setting the tone for strong performance for just about all global equity markets. Bonds joined in the party too, with yields tumbling down as the US 10-year yield finished much closer to 4.5% than the near 5% level it began the week. Oil continued to sell-off seemingly unaffected by the escalation of trouble in the Middle East, and Sterling staged an end of week surge against the dollar, although that story was more about USD weakness than pound strength.
After three tough months for equities and bonds, we got one good week and all sorts of market bulls were emerging from wherever bulls go when the bears are playing, to trumpet the soft-landing scenario or at least to dispel the ‘higher for longer’ narrative that had spooked investors. The new prognosis seems to be ‘high for longer’, only a nuance of grammatical differentiation, but enough to send yields tumbling and equities surging.
So, let’s take a look at what caused the shift…
Yields were mixed-to-higher through the first half of the week, but rallied sharply on Wednesday after the Treasury slowed the rise in long-end Treasury coupon issuance, followed by ISM manufacturing coming in weaker than expected. But the fireworks started when we heard from J Powell at the Fed on Wednesday night. Not only did they leave interest rates unchanged, but investors prepared for a stringent “hawkish hold” stance on Wednesday, were met with an unexpected shift from the Federal Reserve chairman, signalling the possibility that the cycle of interest rate increases might have concluded. Powell was clear that the Fed will be quite patient before raising rates again and will give cumulative rate hikes and tighter financial conditions more time to feed through to the economy.
With investors now firmly in a good mood, all eyes turned to the non-farm payrolls numbers due out last Friday, which would provide an indication if the monetary tightening of the last 18 months was finally starting to slow the jobs market? As the numbers hit the screens, they weren’t disappointed, leaving equity and bond markets heading higher into the close, as underweight portfolio managers scrambled to catch some of the week’s rally. Specifically, the number of non-farm jobs expanded by 150,000 in October – less than expected – and they were accompanied by downward adjustments for the preceding two months. The rate of increase in monthly earnings also slowed and the unemployment rate climbed to a near two-year peak of 3.9%, hinting at a softening in employers’ appetite for hiring.
OK, so one swallow doesn’t make a summer, but taken with the downward revisions, these figures point to emerging weaknesses in the labour market, just what the Fed have been waiting for. It would appear from the market’s reaction that this has been taken as the coup de grâce for any further rate hikes… If you really want to see the glass half full, then you could even take the next step and say the mild loosening in this jobs report is consistent with what you would expect from an economy on its way to delivering a soft landing. If you have more of a glass half empty disposition, then you could potentially see this as the beginning of a more troubling economic downturn, but I don’t think I will go down that rabbit hole today.
We also heard from the Bank of England in their November meeting, here the Monetary Policy Committee chose the same route as the Fed, as they decided to hold the Bank Rate steady at 5.25% (a decision made easier by the absence of significant new data on inflation and wages). The tone of the rhetoric that accompanied the news was, decidedly more hawkish, as the MPC stressed that a tight policy stance would be required for ‘an extended period of time’. That reflects the fact that despite good recent progress, inflation in the UK is running much hotter than for most of the G7, still around 5%.
Somewhat worryingly, the BoE also suggested that the economic picture for the UK is not as rosy as the US, as they lowered their short-term growth forecasts, reflecting recent sluggish economic activity and a more cautious view of potential output. Expressions like ‘broadly flat’ and ‘subdued’ were used to describe the GDP outlook, which now is projected to record zero growth in 2024, down from the 0.5% expansion previously expected. Unemployment is also expected to tick up more quickly, ending this year at 4.3% rather than the 4.1% previously expected, as businesses make more cuts to cope with higher rates. The mix of stubbornly high inflation and reduced business activity, with declining employment, presents an almost impossible challenge for the BoE, and although the MPC has stressed that rate reductions are not imminent… I am not so sure. To my mind the rise in unemployment is consistent with an economy more likely to contract than grow and despite the tough talking I see a reversal in rates coming sooner rather than later.
It’s a similar picture for Europe, here too the ECB also refrained from any rate increases last week, which was probably more of a certainty than the Fed pause! In Europe, there are clear signs of economic slowdown, as data last week confirmed the Eurozone manufacturing PMI remained in contractionary territory at 43.1 in October. Meanwhile, Germany also experienced a slight uptick in unemployment to 5.8%. Again, these releases suggest to me that the ECB may also pivot to lower rates faster than their language would suggest and they could potentially be the first major central bank to cut rates.
The fall in the oil price last week might suggest that the conflict in the Middle East between Israel and Hamas is likely to be contained within Gaza, but I think that conclusion would be premature at best, more likely naive. Things continue to escalate and a report that hit my desk from the excellent team at BCA research put a very strong case for de-risking portfolios. They argue convincingly that;
‘…our new final probabilities are 46% for minor oil shocks and 30% for major oil shocks, with only 24% odds for maintaining the status quo ‘.
The decision tree schematic from BCA makes tough reading. Part of their argument was based on an expectation that the Hezbollah leader Hassan Nasrallah would on Friday announce that Hezbollah would enter the war against Israel to prevent the destruction of its ally Hamas. I am very (very) pleased to report that didn’t happen and in a rambling speech from Nasrallah, there were two encouraging things I clung to. The first was that he had had no prior knowledge of the massacre on October 7th by Hamas, and the second was to call for a ceasefire in Gaza and a request for other people to make it happen. That suggests to me that Hezbollah are not going to be the ones that inflame the situation, but with both Russia and Iran manoeuvring in the background, they could yet end up as the pawn that’s moved first. We keep a watching eye on events with the oil price probably the clearest barometer to use.
US Earnings Season
And for those of you still interested in how individual companies are faring this year (it really has been a year where macro has been the primary driver of markets), barring disappointing results from Apple it was another good week for Q3 US earnings. Again, lifting comment from FactSet, who provide the most comprehensive guidance…
Final point: Though the results coming in are proving to be better than expected, forward guidance has actually been lowered for 2024, which probably explains why company share prices like Apple have fallen after reporting. According to FactSet, ‘For 2024, analysts are calling for (year-over-year) earnings growth of 11.9%, which is below the estimate of 12.2% on September 30 ‘.
I promise a shorter Market Matters next week, but last week’s crazy rise deserved due recognition in word count!