Markets are still roaring upward after US inflation slowed in October, removing a key impetus behind the Federal Reserve’s monetary tightening campaign. Equity futures are pointing to further gains after stock markets added more than a trillion dollars in value during yesterday’s session, ten-year Treasury yields are holding near 4.47 percent after tumbling more than 19 basis points in the space of a day, and the dollar is flat after losing almost 1.2 percent against a basket of major currencies. Investors now expect the central bank to cut rates four times in 2024, up from the three previously expected, with the first move coming in May.
The data suggest that a long-feared re-acceleration in inflation isn’t in the offing: After surprising to the upside for several months, owner’s equivalent rent, hotel fees, and medical care costs slowed more than expected, and statistical diffusion measures – which capture the share of categories seeing unusually-large increases – pointed to a narrowing in price pressures.
But the market reaction seems excessive relative to the change in fundamentals: On a month-over-month basis, core inflation undershot the consensus forecast in October by a mere 0.073 percent, rounded up to 0.1 percent. Underlying aggregates like Jerome Powell’s preferred “supercore” measure remain well above the central bank’s target range. And
Market positioning and calendar effects may be distorting things: Traders and forecasters have been virtually unanimous in seeing inflation risks tilted to the upside, meaning that most were wrongfooted by October’s below-consensus print. Institutional incentives to top-tick yields are embedded across a broad cross-section of the global asset management industry, giving investors clear motivation to buy whenever an argument can be made for a sustained drop in long-term rates. And with rebalancing efforts beginning ahead of year end, the rush to reposition portfolios is likely exacerbating flows out of the dollar into alternative currency blocs.
There’s scope for correction: Investors seem positioned for an “M&M” economy that melts in the mouth, but not in the hand – one in which a sharp drop in inflation and a severe economic downturn forces the Federal Reserve into an abrupt and aggressive u-turn, but one that fails to generate equity market declines or a surge in offsetting safe haven flows. We suspect this rickety construction will begin to fall apart in coming weeks and months as economic fundamentals deteriorate more profoundly, with consumer spending and labour market data offering the most likely vectors for downside shocks.
The dollar’s best days are likely behind it, with oversold conditions gradually correcting themselves – but huge cross-national differences in household and corporate balance sheets mean other currencies remain far more vulnerable to selling in the event of a downturn.
Elsewhere in global markets:
The House of Representatives approved a bill which should keep the government funded into the new year, temporarily averting a potentially damaging shutdown. The measure, which was approved by 127 Republicans and 209 Democrats, is expected to pass the Senate and land on President Biden’s desk before Friday. It does not include money for Israel or Ukraine, and under its provisions, separate appropriations processes will be required to keep key agencies operating beyond the middle of January.
Inflation subsided more quickly than expected in the United Kingdom last month, helping ratify expectations for rate cuts beginning in the second half of next year. On a year-on-year basis, consumer prices climbed 4.7 percent, lower than the 4.8 percent consensus forecast, and below the 6.7 percent pace measured in September. The core measure, which excludes energy and food, fell to 5.7 percent, down from 6.1 percent in the prior month, giving markets room to fully price three rate cuts into the curve between June and December 2024. The pound is ticking lower, moving against the broader dollar-selling tide.
The Chinese economy turned in an uneven performance in October, with Golden Week holidays helping obscure underlying growth patterns. According to a raft of data from the National Bureau of Statistics, retail sales rose 7.6 percent in October from a year earlier and industrial production climbed 4.6 percent – both slightly better than expected – while the property sector remained mired in a downturn and fixed asset investment kept weakening. This comes as officials make reassuring noises on the domestic and international stages and the People’s Bank of China steps up its liquidity injections. Investors are turning more optimistic, pushing equity indices higher and adding stability to an already artificially-elevated yuan.
The Canadian dollar is trading well above yesterday’s open on a narrowing in rate differentials relative to the US, a drop in external borrowing costs, and an improvement in overall risk appetite. We think the path forward will be defined by two separate phases: The first, characterized by a softening global interest rates and lasting a few months, should provide relief to Canada’s deeply indebted private sector and help support the loonie. But the second, perhaps beginning in the early new year, should see US consumer demand and cross-border investment flows falling, squeezing Canadian exports and clobbering business investment. This – combined with the damage inflicted by still-high borrowing costs – is likely to lead to renewed currency weakness. If this plays out, the loonie could climb a couple of cents from today’s levels, but revert lower toward the tail end of first quarter 2024.
US retail sales likely tumbled in October, with declining vehicle volumes and a drop in gasoline prices helping pull the headline print down to -0.3 percent – or lower. Control group sales—which exclude vehicles, gas, food, and building materials—probably turned in a slightly better performance, edging higher on a month-over-month basis, but should also exhibit signs of strain as earnings growth slows, pandemic era savings are depleted, and consumers turn more cautious. That said, we’ve been repeatedly surprised by the strength of US household demand, and upside shocks are possible. (08:30 EDT)