Big Market Turnaround: Equity Rebound and Lower Dollar and Sovereign Debt Yields

October 4, 2022

Market expectations of how much further the federal funds target rate will be raised in the coming six months have been scaled back significantly. The catalyst has been evidence of softer U.S. demand, notably visible in yesterday’s ISM-compiled purchasing managers survey of manufacturers, which dropped 1.8 index points to a 28-month low of 50.9. Sub-indices for employment, industrial orders, and pricing pressure fell by 5.5, 4.2, and 0.8 points to 48.7, 47.1, and 51.7, respectively. A separate U.S. data releases yesterday for construction spending revealed a second consecutive monthly drop of 0.7% in August after July’s 0.6% fall.

The market has likely overreacted. A key policy misjudgment during the inflationary period of the 1970s was that U.S. monetary policy repeatedly eased back prematurely in the face of data suggesting slower growth. One would hope that not reacting to a single or couple of data points is presumably now hard-wired into the Fed’s policy culture, and Fed rhetoric remains quite hawkish in tone. Inflation in the U.S. and other countries remains far too high and labor market measures are far too tight for officials to base coming policy moves on hope rather than solid confirmation of what they wish to see. In that vain, note needs to be made that the U.S. S&P Global-compiled manufacturing PMI index, in contrast to the more widely followed ISM index, went up in February to a 2-month high reading of 52.0. Ease up too quickly on the steepness of interest rate tightening with this mixed picture, and Fed officials could be tempting to push medium-term inflation expectations upward.

Being short-term oriented, markets nonetheless reacted sharply today.

  • Ten-year sovereign debt yields tumbled 15 basis points in the U.K., 14 bps in Italy, 11 bps in Spain and France and 5 basis points in the case of the U.S. Treasury bond, which at 3.59%, is 42 basis points lower than the peak touched about a week ago.
  • In equity trading today, markets were closed in China and Hong Kong but closed up 3.8% in Australia, 3.0% in Japan, 2.5% in South Korea, and 2.3% in India. European markets are presently up 3.3% in France, 2.9% in Germany, 2.6% in Italy, and even 1.9% in the U.K. where anachronistic fiscal plans still look very inappropriate. U.S. stock futures are up about 1.5-2.0% after posting very sharp advances on Monday.
  • OPEC plus oil ministers meeting tomorrow in Vienna are expected to agree on a production cut of at least one million barrels per day, so it’s not unexpected to see WTI oil up another 0.6% so far today. Gold has also traded 0.6% higher and Bitcoin has climbed 1.5%.
  • The DXY weighted dollar index is a tad more than 3% below its recent peak, having lost 0.5% overnight. The dollar fell 0.6% against the euro and 0.4% relative to the Swiss franc. At CHF 0.9886 and $0.9883, those currencies exhibited a rare eclipse.

Euroland’s record 10.0% rate of CPI inflation shows scant sign of abating. Today’s producer price report for the joint currency bloc showed a stupendous 5.0% month-on-month leap in August on top of a 4.0% advance in the prior month. Year-on-year PPI inflation shot up to a record 43.3% from 13.4% in August 2021 and -2.6% in August 2020. Europe’s energy crisis — brought on by over dependence on Russian supplies and the war in Ukraine — was the main PPI driver, with gains in August of 11.8% on month and 116.8% compared to August 2021. However, non-energy PPI inflation of 14.5% was pretty lofty, too.

Core CPI inflation in Tokyo for September, a leading indicators of nationwide Japanese consumer prices, accelerated 0.2 percentage points further to an 8-year high of 2.8% in September. This data series excludes perishable foods but includes energy.

Policymakers at the Reserve Bank of Australia helped reinforce markets’ reassessment of coming monetary restraint around the world by throttling back the incremental rise of the Official Cash Rate to 25 basis point from moves of 50 basis points at the previous four monthly reviews. The initial rate hike last May, like today’s had been an increase of 25 bps to 0.35% from a pandemic low of 0.10%. Markets had been anticipating another 50-basis point hike today instead. In response to the surprise, the Aussie dollar fell 0.6% overnight, and the government’s 10-year sovereign debt yield plunged 17 basis points. In explaining today’s smaller rate hike, Governor Lowe’s statement points out, “The cash rate has been increased substantially in a short period of time. Reflecting this, the Board decided to increase the cash rate by 25 basis points this month as it assesses the outlook for inflation and economic growth in Australia.” He indicates that more increases will be coming, but that reassurance did not balance investors’ surprise at the downsized incremental pace. The statement concedes that inflation will go higher in the very short time, continue to exceed 4.0% next year and not return to target before 2024.

The Bank of Israel yesterday unveiled a 75-basis point hike of its policy interest rate to 2.75%. That followed a similar-sized hike in August and brought the amount of cumulative increase to 265 basis points since April. The new 2.75% rate level is its highest in almost 11 years. Israeli CPI inflation fell 0.6 percentage points to 4.6% in August but remains above the 3% target. A statement leaves little doubt that more rate hikes are coming.

South Korea’s manufacturing PMI fell further below the 50 threshold to a 26-month low of 47.3 in September.

Egypt’s non-oil purchasing managers index held steady in September at August’s 7-month high of 47.6, and the Saudi Arabian non-oil PMI edged down to a 2-month low of 56.6 from August’s 10-month high of 57.7.

Now investors wait for the release of U.S. factory orders report and the Labor Department’s JOLTs survey of job openings, hires, and separations. At last month’s press conference, Fed Chairman Powell cited the JOLTs data as a useful additional source of information regarding the evolution of labor market tightness, which officials want to see show more slack.

Copyright 2022, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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