Global Markets Weekly Update: October 13, 2023
Stocks mixed as earnings season kicks off
The major indexes ended mixed as investors weighed inflation data against dovish signals from Federal Reserve officials. Large-cap value stocks outperformed, helped by earnings beats from Citigroup, Wells Fargo, and JPMorgan Chase. The banking giants kicked off the unofficial start to third-quarter earnings reporting season on a positive note, as their profits got a boost from higher interest rates.
The prospect of a widening war in the Middle East following last weekend’s Hamas attacks against Israel boosted energy shares and defense stocks while weighing on airlines and cruise operators. Dialysis provider DaVita also fell sharply on reports that Novo Nordisk’s new dialysis drug, after being widely adopted to treat obesity, also demonstrated success in treating kidney disease.
Dovish Fed signals support sentiment
T. Rowe Price traders noted that sentiment appeared to get a boost at the start of the week, after Fed Vice Chair Philip Jefferson told an economics conference in Dallas that he was mindful that the rise in long-term bond yields might affect the need for future rate hikes. He also acknowledged that policymakers “have to balance the risk of not having tightened enough against the risk of policy being too restrictive.”
Dallas Fed President Lorie Logan, widely considered one of the central bank’s most hawkish policymakers, also surprised some by telling another economics conference that “there may be less need to raise the fed funds rate” because of the higher yields, although she repeated her insistence that rates would need to remain elevated.
The Wednesday release of the minutes from the Fed’s September policy meeting seemed to confirm the shift in official thinking because of higher yields. In particular, while “all agreed that rates should stay restrictive for some time,” officials also agreed that the “Fed should shift communications from how high to raise rates to how long to hold rates." By the end of the week, federal funds futures were pricing in only a 5.7% chance of a rate hike at the next Fed meeting in November versus 27.1% the previous week, according to the CME FedWatch Tool.
Producer inflation surprises to the upside, but consumer inflation falls to two-year low
Slightly hotter-than-expected inflation readings did not seem to sway investor expectations for the Fed’s next move, perhaps due to expectations that officials might also weigh the added uncertainty from the war between Hamas and Israel. On Wednesday, the Labor Department reported that core (excluding food and energy) producer prices rose 0.3% in September, a tick above expectations. The surprise 2.7% increase in year-over-year core producer prices was the highest level since May, however, due to a significant upward revision in the previous month. Core consumer price index (CPI) inflation data, released Thursday, was in line with expectations, rising 4.1% for the year ended September 30, its slowest pace in two years.
Treasury and tax-exempt municipal bond yields decreased sharply over much of the week, eased down by both the Fed comments and a flight to quality following the outbreak of war in the Middle East. (Bond prices and yields move in opposite directions.) In the muni market, longer-maturity bonds benefited from healthy demand and limited supply of favorable bond structures. Primary issuance volumes were manageable with the deals generally experiencing strong demand.
Likewise, issuance in the investment-grade corporate bond market was front-loaded during the week, and most issues were oversubscribed. On Thursday, issuance quieted down in anticipation of the CPI release. According to our traders, the high yield bond market continued to trade well despite geopolitical headlines. Higher-quality below investment-grade bonds performed well due to the downward move in rates. Our traders noted solid demand for new issues—especially higher-quality secured bonds—as cash balances remain healthy. Steady demand from accounts with excess cash due to recent paydowns contributed to the firm tone in the bank loan market.
% Change YTD
S&P MidCap 400
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In local currency terms, the pan-European STOXX Europe 600 Index ended 0.95% higher, snapping three weeks of losses after dovish comments from Fed policymakers and reports that China was considering more economic stimulus measures. Major stock indexes were mixed. Italy’s FTSE MIB rose 1.53%, Germany’s DAX slipped 0.28%, and France’s CAC 40 Index fell 0.80%. The UK’s FTSE 100 Index added 1.41%.
European government bond yields broadly declined due to demand for safe-haven assets after last weekend’s flare up of violence in the Middle East. However, strong U.S. inflation data cushioned the drop in yields. The benchmark 10-year German government bond yield ended near 2.75%.
ECB minutes show September rate hike was a “close call”
The minutes of the European Central Bank’s (ECB) September meeting revealed that “a solid majority” of policymakers voted to raise the key deposit rate to a record high of 4.0%. The decision appeared to be a close call, given the “considerable uncertainty.” Pausing the rate increases “risked being interpreted as a weakening of the ECB’s determination, especially at a time when headline and core inflation was still above 5%,” the minutes said.
German government slashes economic forecast
The German government joined a string of other forecasters and sharply lowered its outlook for the country’s economy this year. According to this updated view, the economy is now projected to shrink by 0.4% due to higher energy prices and weaker demand from major markets like China. Estimates released in April had called for Germany’s economy to grow by 0.4%. The Economy Ministry said it expects economic growth to pick up at the start of next year and then accelerate amid a recovery in consumer demand.
UK economy returns to growth; signs of stabilization in housing market
The UK economy bounced back in August thanks to growth in professional services and education. Gross domestic product (GDP) expanded 0.2% sequentially after contracting 0.6% in July. But the data also showed that construction and production fell.
Japan’s stock markets gained over the week, with the Nikkei 225 Index up 4.3% and the broader TOPIX Index rising 2.0%, continuing their strong year-to-date gains as historic weakness in the yen lent ongoing support. The yen weakened to around JPY 149.6 against the U.S. dollar, from about JPY149.2 the prior week, despite seeing some support from investor demand for safe-haven currencies amid the violent developments in the Middle East. While Japanese authorities have repeatedly stressed that they would act against excess currency volatility, without ruling out any options, there has been no evidence that they have recently intervened to stem the yen’s slide.
Speculation ongoing about monetary policy normalization
The yield on the 10-year Japanese government bond (JGB) fell to 0.76%, from 0.80% at the end of the previous week. Speculation was ongoing about when the Bank of Japan (BoJ) could further normalize its monetary policy, having tweaked its approach to yield curve control (YCC) in July to effectively allow yields to rise more freely, but capping them at 1.0%. Asahi Noguchi, a BoJ Board member, indicated during the week that the central bank has room to maneuver before the JGB yield hits its ceiling and that there is no pressing need to alter its YCC policy.
IMF revises up its forecast for Japan’s growth, price gains
In its October World Economic Outlook, published during the week, the International Monetary Fund (IMF) revised up its forecast for Japan’s growth in 2023 to 2.0% from 1.4% previously. The international organization expects a range of factors—including pent-up demand, rebounding inbound tourism, accommodative monetary policy, and easing supply chain constraints boosting auto exports—to support expansion.
The IMF also lifted its forecast for Japan’s price gains, anticipating that consumer inflation will tick up 3.2% this year, up from a previously expected 2.7% rise. The BoJ is likely to raise its own inflation forecasts in October, as broader-than-expected price hikes, rising crude oil prices, and yen depreciation have exerted upward pressure on prices.
Financial markets in China declined in the first full week of trading after the Golden Week holiday, as softer inflation and trade data renewed concerns that the economy may slip back into deflation. In Hong Kong, the benchmark Hang Seng Index gained 1.87%, according to FactSet.
China’s CPI remained unchanged in September from a year earlier, following August’s 0.1% rise, largely due to weaker food prices. Producer prices fell an above-consensus 2.5% from a year ago but eased from the 3% drop the previous month.
Meanwhile, trade and lending data came in above expectations but remained weak. Overseas exports fell 6.2% in September from a year earlier, slower than the 8.8% drop in August. Imports also shrank by 6.2%, better than the 7.3% contraction in August and marking the seventh straight month of declines. Separately, new bank loans rose to a lower-than-expected RMB 2.31 trillion in September, up from August’s 1.36 trillion. While the above-consensus results signaled that some parts of China’s economy are stabilizing, it was not enough to dispel fears about the country’s weakening growth outlook.
In regulatory news, the China Securities Regulatory Commission (CSRC) announced a ban on domestic brokerages and their overseas units from accepting new mainland clients for offshore trading. Any new investments made by existing clients are to also be “strictly monitored,” according to the statement released on Thursday. In another sign that Beijing is ramping up measures to shore up China’s stock markets, financial regulators—including the CSRC—submitted a plan to launch a state-backed stabilization fund, Bloomberg reported.
Other Key Markets
Various Israeli assets, especially the shekel currency, were pressured by the previous weekend’s Hamas attacks and Israel’s subsequent declaration of a state of war and an emergency situation across the country.
According to T. Rowe Price sovereign analyst Peter Botoucharov, the perception of an existential threat to Israel has taken priority over the domestic political disagreements—such as over far-reaching judicial reforms and other controversial legislation—that have divided the electorate the most since Prime Minister Yitzhak Rabin was assassinated in November 1995. Israel’s leaders have agreed to form a narrow emergency government that will include the current government coalition (Likud and Right of Center parties) and the opposition National Unity party. Importantly, Botoucharov notes that the government has agreed that no resolutions will be advanced through the Knesset legislature during the war that are not related to managing the war. This underscores the importance of social and financial stability that needs to be ensured by major Israeli institutions, including the Bank of Israel and the Ministry of Finance.
With regard to Israel’s fiscal situation, the outlook, which had been supportive, has turned more neutral and is likely to worsen in view of the probable increase in military spending. Botoucharov anticipates that the 2023 budget deficit is likely to widen to and above 2.0% of GDP versus a target of 1.2% of GDP. He also projects that there will be a 2024 budget deficit of about 1.4%. These deficits would follow a year of a budget surplus of 0.6% in 2022 and a deficit of 4.3% in 2021.
Regarding inflation, there has been—as expected—a material decrease in the inflation rate in the last few months. However, Botoucharov believes that inflation, as measured by the CPI, is likely to stay above the central bank’s 1% to 3% target range for the rest of the year, due in part to the increased pass-through of inflation stemming from a weaker currency. As a result, he expects monetary policy to remain tight, with the key interest rate likely to remain at 4.75% in the months ahead.
Central Eastern Europe
During the week, the Czech Republic government reported that inflation in September was at a year-over-year (yoy) rate of 6.9% compared with 8.5% in August and expectations for a reading of 7.5%. According to T. Rowe Price credit analyst Ivan Morozov, this big downside surprise in Czech inflation was mainly the result of some one-time factors. Nevertheless, he believes that the momentum in Czech inflation is taking both headline and core measures of inflation below the central bank’s inflation target. As a result, Morozov would not be surprised to see the central bank begin cutting short-term interest rates by the end of the year.
Hungary’s government also reported a lower-than-expected yoy inflation rate of 12.2% versus 16.4% in August and expectations for a reading of 12.4%. As with the Czech Republic, inflation momentum now indicates that inflation is at the central bank’s target—specifically, month-over-month core inflation has been hovering around 0.2% to 0.3% for the last several months; this is consistent with an annual rate of about 3%. Hungary has already been reducing certain interest rates in the last few months, but due to risks of currency depreciation, Morozov believes that the central bank is likely to slow the pace of rate cuts.
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