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Peak rates optimism delivers market relief

Markets are steadying after last week’s stunning rally. Equity and commodity futures are edging higher ahead of the North American open, the dollar is trading near a six-week low, and Treasury yields are lower across the curve, with the ten-year trading at 4.59 percent after breaking the 5 percent barrier in late October.

To sum up last week’s events: the Treasury said it would push less bond supply into markets than had been feared, the Federal Reserve turned slightly more dovish, and Friday’s jobs report showed labour markets showing clear signs of easing, giving the central bank further room to back off its “higher for longer” stance on rates. Market-implied odds on more monetary tightening in December fell below 5 percent, down from 20 earlier in the week, and investors jumped to price at least four cuts into the curve between now and January 2024.

As previously indicated, we suspect these moves were heavily position-driven, with dovish newsflow driving leveraged speculators to unwind long dollar and short Treasury positions en masse. Some consolidation looks likely in coming days as trading conditions normalize – implying that the dollar could recover some ground – but it is also clear that the long greenback bull market has run out of momentum, helping provide relief to currencies elsewhere.

More broadly, it is important to recognize that at this stage in the monetary policy cycle, outsized moves in yields – both upward and downward – risk planting the seeds of their own demise. Central bankers – who want to avoid breaking something in the economy and financial system – are unlikely to welcome an uncontrolled “melt up” in long-term rates, and have every incentive to jawbone them lower. Equally, a sharp decline could generate an unwarranted easing in financial conditions, reawakening the inflationary dragon and putting rate hikes back on the table – something policymakers are likely to push back against. This should imply a more rangebound trading environment for now, with instances of overegged price action repeatedly countered by official rhetoric – until something more shocking occurs, of course.

Bank of Japan Governor said the central bank was unlikely to lift rates out of negative territory by year end, suggesting that clear-cut evidence of sustained wage price increases could take many months, if not years, to materialize. The yen is slightly softer, but is stubbornly clinging to gains achieved during last week’s broad-based dollar selloff.

Still ahead today, the Fed will deliver its latest Senior Loan Officer Opinion Survey, which measures the proportion of domestic banks tightening their lending standards for business borrowers, helping quantify financial conditions in the US economy. Extrapolating from last week’s cautionary comments from Chair Powell, it seems likely to show a rise in the number of lenders responding to higher funding costs with more restrictive policies in the third quarter, and might foreshadow a deeper-than-anticipated downturn ahead as the flow of commercial credit weakens in parallel with slower wage gains and a rundown in “excess savings” on the consumer side of the economy.

The Reserve Bank of Australia is widely expected to respond to a recent escalation in inflation pressures with a rate hike at this evening’s meeting. We hesitate to ascribe too much importance to decisions from central banks in Australia and Canada – with small, open economies, huge exposures to export markets, and massive domestic credit vulnerabilities, they’re typically price-takers, not price-makers when it comes to setting policy – but global markets have taken to using them as bellwethers for the global monetary cycle, and more tightening could lead traders to question the terminal rate assumptions currently built into developed-market curves.


Still Ahead

MONDAY

The Reserve Bank of Australia is widely expected to re-initiate its monetary tightening campaign after inflation accelerated in the third quarter, with market consensus supporting a 25 basis point increase in the cash rate target to 4.35 percent. This is a reasonable base case, but with consumer spending softening, employment conditions easing, and housing markets remaining structurally vulnerable, officials may opt to hold long-run price projections near current levels – a move that might lessen the need for higher rates in the short term. (22:30 EDT)

TUESDAY

Mexico’s central bank is likely to continue conveying its own version of the “higher for longer” message, holding its benchmark rate at 11.25 percent for a fifth consecutive meeting and warning markets to expect more of the same until well into 2024. Until the US slows in a meaningful way, we don’t see this changing: with inflation expectations remaining above target and the domestic economy performing well on growing remittances, exports, and investment, there’s little need to follow other emerging market central banks into a cutting cycle, and supportive yield differentials are helping sustain strong inward capital flows. (14:00 EDT)

FRIDAY

The British economy may have entered the early stages of recession in the third quarter, with gross domestic product seen shrinking -0.1 percent after expanding 0.2 percent in the second. Further declines are likely in the new year as the consequences of the Bank of England’s tightening efforts hit home. (02:00 EDT)

Market Retreat Continues as Yields Climb
Hawkish Kashkari Comments Pour Cold Water on Markets
Market Momentum Fades After US Long Weekend
No news is good news
Dollar Cruises Toward Weekly Gain on Fading Easing Expectations
Twists & turns

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