Two steps forward and one step back, or is it one step forward and two steps back? I’m going with the former as far as the US economy, which serves up more mixed signals than you can shake a stick at. In Europe and the UK, the situation is different with the combination of faster-than-expected disinflation and flatline economic growth providing the ECB and BoE, respectively, with a growing arsenal of reasons to ease off of tighter monetary policy sooner rather than later. The UK remains in the biggest pickle as inflation remains higher than its G7 peers, making rate cuts a more difficult decision. Japan is an entirely different matter altogether, although perhaps the most interesting of all developed countries since speculation is growing that the Bank of Japan is nearer to “normalising” its monetary policy, bringing its policy approach more in line with its G7 peers. It is a slippery slope though, because although inflation seems to have peaked, the country’s economy is shrinking, evidenced by the revised 3Q23 GDP read – already negative – worsening (to -0.7% Q-o-Q). The Yen has been like a yoyo around ¥150/US$1.00 since late September, albeit it gapped down on Friday following dovish BoJ statements, ending stronger now for the fourth week running. And in the “Middle Kingdom”, the world’s second largest economy is trying desperately to find the secret sauce to emerge from its period of moribund economic growth, most recently announcing that more fiscal and monetary stimulus would likely be in the cards for 2024. This couldn’t come soon enough, as China announced on Saturday morning that CPI was negative 0.5% for November, extending a troubling period of deflation that has occurred since the summer.
This sets the stage perfectly for what will certainly be the focus this coming week, with all eyes on the last policy meetings of the year for the world’s four major central banks. Bets are on the Federal Reserve, the ECB and the Bank of England doing nothing, while speculation around whether or not the Bank of Japan might “nudge” its policy towards a more hawkish stance remains rampant. The table below should prepare you for the upcoming central bank meetings.
Summary of week by country / economic bloc
US: Mixed economic data continues to trickle in Stateside, with the jobs market remaining the most confusing to interpret. JOLTS data early last week suggested that new job openings were slowing sharply, but the jobs report on Friday painted a very different picture. New payroll additions (199,000) came in higher than expected for November, and unemployment fell back to 3.7% (vs 3.9% expected). As could have been anticipated, bond investors weren’t thrilled with the news since yields have been dropping like a stone over the last five weeks in anticipation of a worsening US economy. The bizarre thing is that stocks have also been rallying throughout this period as the “lower yield” argument superseded the “lower earnings” narrative. Sure enough, the stronger-than-expected jobs report on Friday turned the “bad news is good news” narrative on its head, with good news now apparently meaning….. good news. It’s strange, isn’t it? Whether it’s good news or bad news for the economy, it’s all good news for US stocks as they continue to register gains.
Europe: In the Eurozone and the UK, the economic data is more consistent suggesting a stagnating economy and faster disinflation. Consistent with the “bad news is good news” narrative in the US, equity investors in Europe lapped up worse-than-expected economic news last week as a sign that both the ECB and BoE would pivot faster than had been anticipated, and perhaps more vigorously.
Japan: Very much marching to its own beat, it’s hard to say what the Bank of Japan might do at its next meeting, although the consensus seems to be that the central bank will continue to inch towards a normalisation of its monetary policy. Bold moves in this direction aren’t expected until April 2024, although this very methodical central bank seems to be laying the groundwork now. Recall that the BoJ is the only G7 central bank that has a negative overnight bank borrowing rate (-0.10%). The bank has been practicing yield curve control (YCC) since 2016 with the 10-year JGB now capped at a target of 1.00%. A shift towards a more hawkish policy would eventually make sense, although the momentum in this direction encountered a speedbump last week with a revision down to already negative 3Q23 GDP. Nonetheless, the Yen rose sharply as investors signalled growing confidence that the BoJ would fall in line with its peers sooner rather than later.
The Fed, the ECB and the BoE: the paths ahead
As far as the paths ahead following this round of meetings, consensus seems to be converging around the following:
The Fed: First Fed Funds rate cut in May (was March last week at this time) according to the CME FedWatch Tool, with a total of five 25bps cuts expected during 2024 (y/e Fed Funds target range of 4.00% to 4.25%)
The ECB: According to #Bloomberg, the forward swaps curve is projecting the first ECB rate reduction in March, with a total of six 25bps cuts during 2024 (y/e level of 2.50%)
Bank of England: According to #Bloomberg, the forward swaps curve is projecting that the BoE will reduce rates three times in 2024 in 25bps increments, starting in June 2024.
My readers will know that I have said for several weeks now that the ECB would lead the pack, and this now appears to be the consensus view. I also expect that in spite of what the swaps market is saying, the BoE will pivot before the Fed because the economy here is sufficiently dire and likely to worsen quickly, with the risk being that inflation remains persistent longer than expected.
MARKETS LAST WEEK
Global equities: Mixed on the week. US equities were slightly better due to a Friday afternoon rally, European bourses were better (reflecting expectations of a faster-than-expected pivot), and Asian markets were worse. The STOXX 600 closed at its highest level since February 10, 2022. China equities remain in a funk although they are cheap-as-chips, and Japanese equities suffered from growing conviction that the BoJ might soon reverse course and start to tighten monetary policy, also reflected in a sharply higher Yen.
US equities: US stocks were generally better on the week by modest amounts, with the Russell 2000 leading the gains, followed by the NASDAQ. The S&P 500 closed at its highest level since March 29, 2022.
US Treasuries: The 2y-10y yield curve inversion steepened last week, mainly attributable to a sharp increase in the yield (+15bps WoW) of the more policy-sensitive 2y UST. 10y yields were virtually flat WoW.
Corporate credit: Corporate credit continues to be unphased by gyrations in the US equity market and mixed economic news. Investment grade spreads were flat on the weak, but spreads in the more credit-intensive high yield market declined a further 10bps. In other words, no credit concerns are being signalled by corporate bond (credit) investors, at least not yet.
Other assets: As fascinating as the rise in the price of gold and the fall in the price of oil, the meteoric increase in the price of Bitcoin simply cannot be ignored. The benchmark crypto has been on steroids since late September. In the fourth quarter alone (so far), BTC has increased 64.1%, boosting its YtD return to 166%. Why? Don’t ask me! In any event, as influential as a few folks might think Bitcoin is, the currency with a far broader collateral effect into other asset classes remains the USD, which seems to be constantly written off as it weakens (or keeps trying to). The reality is that the USD ended the week stronger (+0.8%). Perhaps even harder to believe based on constant press suggesting the contrary, the greenback is actually up slightly (+0.5%) YtD. I would expect this given the relative position and strength of the US economy vis-à-vis other country pairings.
The tables below provide detail across various global and US equity indices, the US Treasury market, corporate bonds and various other asset classes.
Corporate bonds (credit)
Safe haven and other assets