• US markets pulled back with all major benchmarks finishing lower by at least 4.0%, with the Fed’s updated policy path being major catalyst. It is the 5th decline in the last 6 weeks for major indices.
• The 2-year treasury yield broke above its 11-year high to trade as high as 4.25%. Similarly, the 10-year treasury yield rose above 3.8% for the first time since 2010.
• The Federal Reserve released their anticipated 75 bps rate hike, which was their 3rd quarter point hike in the last 3 meetings.
• Since the initial hike no other hiking cycle has started this steeply since the Fed started targeting the effective funds rate in the 1980’s.
• The American Association of Individual Investors (AAII) survey shows bullish sentiment reached its lowest levels since April, with only
17.7% of respondents remaining optimistic. Respondents for a bearish outlook jumped to 60.9%, leaving the bull-bear spread at -43.1%, which was worse than the lows seen during: The dotcom bubble and the global pandemic.
• In Germany, the Business Confidence index deteriorated further in September to the lowest level since April 2020 on energy concerns. The DAX index declined 3.59% last week.
• In Italy, Giorgia Meloni, leader of the Brothers of Italy party, is set to succeed Mario Draghi as the new Prime Minister following general election. The Italy 10-year yield jumped 21bps on Monday to 4.18%.
• In Japan, the government intervened in the foreign exchange market on Thursday to support the yen after the currency slid to a 24- year low versus the dollar.
US Weekly: US markets pulled back this week with all major benchmarks finishing lower by at least
4.0%, with the major catalyst being the Fed’s updated policy path. The anticipated 75 bps hike was confirmed last week as markets shifted to risk-off mode, following the Feds announcement that they raised the Fed funds effective rate to 3.08 (Range now stands at 3.00%-3.25%).
The hike was the 3rd quarter point hike this year, and continued to signal the central banks strong
resolve to get double digit inflation under control. It also brought to light the unprecedented pace of rate-hikes in modern history, with no other hiking cycle starting this steeply since the Fed started targeting the effective funds rate in the 1980’s.
Following the announcement on Wednesday US equities initially rallied before selling off to finish on the lows of the day. Ultimately, the S&P 500 settled down 1.71% for the session, followed by losses on Thursday and Friday, 0.84% and 1.72% respectively. This is the 5th decline in the last 6 weeks for major indices, with the Dow Jones registering new lows for the year. The S&P 500 logged a new year-to-date
low in Monday’s session, bringing its year-to-date losses to 22.43%.
Energy was the week’s worst performing sector down 9.00%, driven by the continued decline in oil prices. Consumer discretionary was another underperformer as concerns regarding consumer spending bubbled to the service amid higher lending rates. Defensive sectors such as Healthcare, Utilities, and Consumer Staples, all outperformed, but it is worth noting all 11 sectors did close lower by at least 2%, with few places to hide from the risk-off tone gripping markets.
The Dollar continued to rise, hitting new 20-year highs against multiple crosses, weighing on gold prices (which dropped 2.0%) and other commodities. A key gauge for raw material prices tumbled to the lowest in 8-months amid a strong US Dollar and mounting fears of a global recession. The Bloomberg commodity index, which tracks futures from oil to copper to wheat, fell to its lowest levels since January 24th and has lost almost 22% since peaking in June and has erased all of its gains since Russia’s invasion of Ukraine. More specifically, WTI Crude oil shed just under 8% on the week, also dropping below pre-Ukraine crisis levels, and neared its lowest levels since the start of the year.
With central banks around the world continuing to tighten monetary policy, sending investor sentiment near its lowest levels since the Global Financial Crisis of 2007-2008, the bond market reacted drastically as yields across the curve reached new decade highs.
The 2-year treasury yield broke above its 11-year high to trade as high as 4.25%. Similarly, the 10-year treasury yield rose above 3.8% for the first time since 2010. Inversion of the 2yr/10yr is a fairly accurate historical indicator of an upcoming recession, and throughout the quarter the 2yr/10yr spread has consistently hovered around -0.50%, the highest levels of inversion seen in nearly 40 years.
Although nominal rates this high in a broad historical context are not exactly noteworthy, as we have experienced significantly lower yields in much of the past decade, the inversion between the 2yr and 10yr continues to be watched closely by investors.
MORE FED RATE HIKES?
While last week’s Fed rate hike caught the attention of the market, the real market moving news was not the hike itself but the details of the market projections. The dot plot leaned hawkish with the median rate standing at 4.4% by the end of 2022, implying another 125bp worth of hikes over the final 2 meetings of the year. The expectations for the terminal rate now stand slightly higher at 4.6% in 2023, but if inflation persists, could be upwards of 5%. Additionally, dampening the outlook are higher unemployment, higher inflation and lower GDP numbers (both core and headline) versus original projections.
The new estimates put to bed much of the hope of early-mid 2024 rate cuts, with the Fed planning to “Raise and Hold” until they are certain the measures had proven efficacious.
Further dampening sentiment were Fed chair Powell’s hawkish leaning comments, saying “We want to see growth continue to run below trend, movement in the labor market showing return to a better balance between supply and demand and clear evidence that inflation is moving back down to 2%.” When asked later if the chairman supported the dot plot outlined, he added that it was “a likely and plausible path”.
The comments came as a slight surprise to some, since the Fed had continued to assert, they would not need to meaningfully decrease GDP growth in order to combat inflation. However, given the persistence of inflation, and a robust consumer this no longer seems to be the base case, with Fed officials now seeing the need to slow GDP in order to control inflation.
After this most recent downturn in equity prices, paired with higher rates and tighter financial conditions, investor sentiment saw further deterioration. According to the most recent AAII (American Association of Individual Investors) survey, bullish sentiment reached its lowest levels since April, with only 17.7% of respondents, remaining optimistic on the outlook of the market. The move lower marked the largest sequential decline since early June and was the 44th consecutive week below the 38.0% historical average. Respondents for a bearish outlook jumped to 60.9%, leaving the bull-bear spread at -43.1%, which was worse than the lows seen during:
• The Dotcom bubble
• The Pandemic
• And was not far off the 51.4% trough during the Great Financial Crisis
Additionally, Bank Of America’s Bull & Bear indicator returned to zero after (fully bearish) recovering earlier this year, with analysts commenting that investor sentiment is “unquestionably” at its lowest levels this decade.
The Bloomberg World index dropped 4.92% last week, with growth down 5.24% and value down 4.95%. Brent crude oil futures finished the week 5.69% lower as the Fed rate hike reignited fears of recession and boosted the dollar. The foreign exchange market was once again the main stage for real-time market adjustments following monetary policy decisions. In fact, multiple countries intervened in the FX market to attempt to stabilize their currency. Global yields rose in unison, but the selloff was more pronounced in countries with easy monetary policy.
In the United Kingdom, the pound fell to record low on Friday after the government announced more tax cuts. The primary concern from investors is that additional fiscal relief would increase liquidity in the economy and boost inflation. Gilt yields surged past 4% and British stocks declined close to 2% on Friday. Traders are now pricing in an emergency rate hike from Bank of England (BOE) to stabilize markets.
In fact, 200bps rate hikes by the BOE’s November meeting is now the consensus. BOE Governor, Andrew Bailey said the Central Bank is monitoring financial markets and will not hesitate to lift rate “by as much as needed” to bring inflation back down to 2%.
Christine Lagarde told European Union lawmakers on Monday that she expects the ECB to lift rates for several meetings. Money-market investors are now pricing in another 75bps in October. The Euro STOXX index declined 4.61% last week, with real estate down 11.7%. In Germany, the Business Confidence index deteriorated further in September to the lowest level since April 2020 on energy concerns. The DAX index declined 3.59% last week. In Italy, Giorgia Meloni, leader of the Brothers of Italy party, is set to succeed Mario Draghi as the new Prime Minister following general election. Meloni seeks to revise the spending plan for $198 billion of pandemic recovery funds allocated by the European Union. The Italy 10-year yield jumped 21bps on Monday to 4.18%.
In China, the onshore yuan weakened to the lowest level since 2008 last week. The People’s Bank of China said it will reinstate a risk reserve requirement of 20% for derivatives to support the yuan. This measure will make it more expensive for funds to bet against the yuan using derivatives. China’s trade surplus is estimated to top $1 trillion this year, but it will not be enough to offset the yuan depreciation. Indeed, net FX conversion ratio of trade surplus from January to August was 36%, the lowest conversion since 2016 according to Bloomberg and China customs. The Shanghai Composite index dropped 1.22% last week, with real estate down 2.23%.
In Japan, the government intervened in the foreign exchange market on Thursday to support the yen after the currency slid to a 24-year low versus the dollar. Finance minister Masato Kanda told reporters, “the government is concerned about excessive moves in the foreign exchange markets, and we took decisive action just now. We are seeing speculative moves behind the current sudden and one-sided moves in the foreign exchange market.” According to CFTC data, leveraged funds yen positioning remains massively short as Bank of Japan remains committed to provide easy monetary policy. While FX intervention is a temporary fix, interest rate spreads with other major economies will have to narrow to prevent further yen depreciation. The NIKKEI 225 index dropped 1.5% last week.
In Mexico, the Central Bank will hold monetary policy meeting this week as early September CPI print hit 8.76% year-over-year, versus 8.71% estimated. Core inflation rose 8.27% during the same period, showing that inflation is widespread beyond food and energy. The consensus sees a 75bps rate hike, in line with the Federal Reserve pace of tightening. Mexico’s benchmark dollar bond yield is now trading 15bps lower than Brazil’s 10-year USD bond at 5.55%. The last time this spread was as narrow was in September 2020. To put things in perspective, Mexico’s S&P sovereign debt rating is “BBB” with a stable outlook whereas Brazil’s rating is “BB- “.Mexican stocks dropped 2.94% last week.
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