U.S.

Stocks fall slightly as investors try to gauge scale of slowdown

Most of the major indexes gave back a portion of the previous week’s strong gains and closed modestly lower. Growth stocks lagged value-oriented shares, which were supported by gains in the consumer staples sector. The energy sector underperformed, however, as European oil and natural gas inventories reached near-peak levels. Dispelled reports of a Russian missile strike on Polish territory sparked a brief sell-off on Tuesday, but trading volumes remained muted for much of the week. Markets will be closed on Thursday, November 24, in observance of the Thanksgiving holiday.

Investors kept a close eye on earnings reports from some prominent retailers and what they indicated about a potential economic slowdown. Target shares fell sharply after the company reported flagging discretionary spending in recent weeks, but better-than-expected results from Wal-Mart, Ross Stores, Foot Locker, and some other retailers offered a more positive picture. On Wednesday, the Commerce Department reported that retail sales excluding the volatile auto segment rose 1.3% in October, well above consensus expectations and the biggest gain since May.

Labor market remains resilient, while manufacturing slows

Conversely, industrial production fell unexpectedly in October, weighed down by weakness in the energy and materials sectors, and a gauge of manufacturing activity in the Mid-Atlantic region tumbled to its lowest level since May 2020. The week also brought another round of prominent layoff announcements, particularly from Amazon.com, which announced roughly 10,000 job cuts. Jobless claims over the previous week remained contained, however, with 222,000 workers filing for unemployment benefits—claims have remained within a tight range of 214,000 to 226,000 since late September.

Our traders noted that trading started off on a down note on Monday following comments from Federal Reserve Governor Christopher Waller over the previous weekend that the Fed has “a ways to go” before ending rate hikes. Tuesday brought some more encouraging inflation data, however, with core (less food and energy) producer prices in October remaining flat for the first time in two years. The report may have swayed Waller, who stated on Wednesday that recent inflation data had led him to favor a 50-basis-point (0.50 percentage points) hike at the upcoming policy meeting rather than 75 basis points.

Recession indicator touches four-decade high

The U.S. Treasury yield curve inverted further during the week, driving the inversion in the two-year/10-year curve segment—historically, a typical but not conclusive indicator of a coming recession—to its deepest level in over 40 years. Short-term U.S. Treasuries repriced to higher yields, particularly after Federal Reserve Bank of St. Louis President James Bullard said that the Fed’s terminal policy rate should reach a minimum level of 5% and may need to go as high as 7% to achieve the central bank’s inflation objectives. Meanwhile, our traders observed “dip buying” in longer maturities, which helped push long-end yields downward. (Bond prices and yields move in opposite directions.)

The broad municipal bond index advanced meaningfully through most of the week and outperformed U.S. Treasuries by a wide margin. Our traders reported that diminished supply levels and stabilization in the pace of outflows industrywide supported the rally.

Our traders also noted that the combination of relatively healthy corporate earnings and the benign producer price index (PPI) report led to some strength in investment-grade corporate bonds. The primary calendar remained active, and the new deals were met with generally strong demand. The PPI data also bolstered the high yield bond market, which received further support from inflows of over USD 10 billion due to coupon payments, calls, and maturities. These factors provided a “floor” to the market as investors tried to manage cash levels. Although a few new deals were announced, modest overall issuance contributed to favorable technical conditions for the high yield asset class. Conversely, our traders observed that several new deals kept investors focused on the primary bank loan market.

U.S. Stocks

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Europe

The pan-European STOXX Europe 600 Index ended modestly higher in local currency terms. Major regional stock indexes mostly gained ground. Germany’s DAX Index gained 1.46%, France’s CAC 40 Index advanced 0.76%, and Italy’s FTSE MIB Index added 0.90%. The UK’s FTSE 100 Index rose 0.92%.

European government bond yields held near recent highs as European Central Bank President Christine Lagarde said interest rates need to rise more as policymakers seek to fight inflation. Germany's 10-year bond yield held above 2%. Benchmark bond yields in Italy, France, and Switzerland steadied as investors assessed the monetary policy outlook in the eurozone. In the UK, 10-year government bond yields rose after the government announced tax rises and spending cuts.

UK’s Hunt raises taxes but delays large spending cuts

UK finance minister Jeremy Hunt unveiled tax increases, spending cuts, and new fiscal rules in his Autumn Statement, with an eye toward repairing the public finances and restoring Britain’s credibility in international markets. To plug a fiscal hole of GBP 55 billion, the government will raise taxes by GBP 25 billion and cut spending by GBP 30 billion by 2027–2028. Much of a painful squeeze on public spending is slated to occur after the next general election in 2024.

The economic forecasts of the Office for Budget Responsibility (OBR) accompanying the statement suggested that the UK is already in a recession and called for the economy to shrink 1.4% in 2023—the sharpest contraction in Europe. The OBR also projected that the tax burden as a percentage of gross domestic product would rise to 37.1% by 2027–2028—a post-World War II high—while living standards would suffer a record decline.

UK inflation surges, jobless rate steady

Inflation in the UK accelerated more than expected and hit a 41-year high of 11.1% in October, a significant increase from the 10.1% registered in September. Sharp increases in energy bills and food prices were the primary drivers. Meanwhile, the unemployment rate came in at 3.6% for the third quarter, a slight increase from the three months ended August 31. The annual increase in average total pay was steady at 6% in the three months through September; however, growth in pay excluding bonuses rose more than forecast to 5.7%.

Germany’s IG Metall agrees to below-inflation pay deal

Germany’s largest trade union, IG Metall, agreed to a below-inflation pay deal after five rounds of talks and warning strikes. Wages will rise 5.2% from June 2023 and 3.3% from May 2024, with lump sums of EUR 1,500 to be paid in both years. The pay deal, which was below the 8% originally demanded by the union, sets a benchmark for Germany’s 3.9 million metal and electrical sector workers. Separately, investors became less pessimistic for a second month in November, apparently on hopes that inflation could soon slow, according to the ZEW economic institute.

Japan

Japanese equity markets fell over the week, with the Nikkei 225 Index declining 1.29% and the broader TOPIX Index down 0.54%. The rate of core consumer price inflation rose to a 40-year high, exerting fresh pressure on the Bank of Japan (BoJ), which nevertheless remains committed to its ultra-loose monetary policy stance. The Japanese economy unexpectedly contracted in the third quarter of the year, further weighing on sentiment. The yield on the 10-year Japanese government bond rose to 0.24% from 0.23% at the end of the previous week, while the yen weakened modestly, to around JPY 139.8 against the U.S. dollar, from the prior week’s level of approximately 138.8.

Consumer inflation rises at fastest rate in 40 years

Japanese core consumer prices rose at their fastest rate in 40 years in October—excluding fresh food, consumer inflation climbed 3.6% from a year ago, exceeding the BoJ’s 2% target for the seventh straight month. Data showed that not only rising energy costs exerted upward pressure on inflation, but also a further uptick in food prices. In response to the release, BoJ Governor Haruhiko Kuroda repeated his view that the central bank will retain its ultra-loose monetary policy to support economic activity but acknowledged that there could be a further acceleration in the rate of inflation.

Economy unexpectedly contracts in the third quarter

Japan’s gross domestic product unexpectedly contracted an annualized 1.2% in the three months to the end of September 2022, weighed down by historic yen weakness. The country continued to struggle to regain momentum following the coronavirus pandemic, with concerns about a global economic slowdown posing a further headwind. Nevertheless, growing private sector demand, the continued reopening of the domestic economy, and the government’s stimulus measures should support a gradual pickup in economic growth. Separate data showed that Japan’s exports grew less than anticipated in October while imports surged. Although export growth overall decelerated, the auto segment was strong amid solid demand in all major markets.

Japan’s prime minister meets with China’s president

In political developments, Japan’s Prime Minister Fumio Kishida met with China’s President Xi Jinping at the Asia-Pacific Economic Cooperation summit in Bangkok, Thailand. In their first meeting since Kishida took office last year, the two leaders vowed that they would seek to improve bilateral relations between their countries, agreeing in principle to boost communications on security and to promote cooperation in areas including environmental protection, health, and cultural exchange.

China

Mainland Chinese stocks were modestly positive for the week, with the Shanghai Composite Index rising 0.32%, while Hong Kong’s Hang Seng Index performed better, gaining 3.85%.

Investors appeared to balance enthusiasm over easing COVID restrictions against worries about rising cases. The seven-day average of new cases reached above 16,000 by the end of the week, with authorities recording a seven-month high of over 25,000 on Thursday alone, according to Reuters. While the breakout remained widespread, China’s National Health Commission announced that it was stopping mass testing in districts not at risk of community transmission. The Commission also announced plans to create new COVID-focused treatment centers, providing further evidence that the government was backing away from its “zero-COVID” policy despite official statements to the contrary.

Consumers pull back in response to zero-Covid, troubled housing market

The impact of zero-COVID and the troubled housing sector on the consumer was evident in Monday’s October retail sales report, which showed sharp year-on-year declines in nearly all categories; sales of home appliances fell by over 14%, for example. Nevertheless, investors appeared to remain hopeful about recently announced support measures for the property sector. According to Reuters, officials have unveiled 16 new programs to shore up the property markets, including extending loans to both developers and homebuyers.

Late in the week, the People’s Bank of China injected liquidity into the banking system in order to stem a recent rise in bond yields. The rise had prompted retail investors to withdraw funds from fixed income funds, according to Bloomberg, threatening an upward spiral in withdrawals and yields.

Prolonged Biden/Xi meeting raises hopes for cooling tensions

A three-hour meeting in Bali over the preceding weekend between U.S. President Joe Biden and Chinese President Xi Jinping appeared to boost sentiment. President Biden characterized the unexpectedly long talks as “blunt,” but stated that he “absolutely believe[s] there need not be a new Cold War.” The two sides also agreed to restart negotiations on climate issues and other matters.

Other Key Markets

Mexico

Mexican stocks, as measured by the IPC Index, returned about -0.8%. In its most recent monetary policy meeting held on November 10, the central bank raised its key interest rate by 75 basis points from 9.25% to 10.00%. The decision was not unanimous: Four policymakers approved the move, but one dissenter preferred a smaller, 50-basis-point increase.

According to T. Rowe Price emerging markets sovereign analyst Aaron Gifford, the post-meeting statement was modestly dovish, as policymakers highlighted supply-side pressures that are beginning to fade and the progress that they have already made in the current tightening cycle. In this sense, they now see inflation risks as only biased to the "upside" rather than "significantly to the upside" as mentioned in their previous policy meeting. They also noted that October inflation was below the September peak but highlighted that core consumer prices and inflation expectations are still rising. Notably, the statement left out references to downside risks for growth, as third-quarter economic activity has been better than expected. As a result, policymakers no longer see a negative output gap as a factor for bringing down inflation.

Overall, Gifford believes that the Mexican central bank seems to be paving the way for a step down in the pace of tightening and a potential pause in rate hikes in upcoming meetings. This is similar to what some U.S. investors have been expecting from the Federal Reserve.

Brazil

Stocks in Brazil, as measured by the Bovespa Index, returned about -2.9%. The market was closed for a holiday on Tuesday.

While President-elect Luiz Inácio Lula da Silva (Lula) has been participating in a UN Climate Change Conference held in Egypt, his Vice President-elect Geraldo Alckmin has spearheaded efforts to create a constitutional amendment that would allow Bolsa Familía social welfare payments to be permanently excluded from the mandatory spending cap that is intended to keep government spending in line with inflation. If passed, this waiver would give the incoming Lula administration room to boost spending on programs and initiatives that he favors. The proposed amendment, which was presented to legislators on Thursday, would also enable the government to use a portion of revenue above budgeted levels for infrastructure spending outside the spending cap. The amendment is likely to be revised by Congress over the next two weeks, as some lawmakers may attempt to limit the amount of government expenditures that can be excluded from the cap, while others may use this as an opportunity to push for increases in spending elsewhere.