Week ended October 20, 2023: yields spike
I realise my oft-repeated assertion that the 10y UST yield would see 4.5% again before 5% looks increasingly wrong, especially since the 10y yield nearly touched 5% this week. Although my timing for lower yields looks wrong at the moment, I still think UST yields are near their peaks. Currently bond investors are reacting to risks that are related to supply / trade flows in the world’s largest government bond market, not concerns that should be summarily dismissed under any circumstances. However, there is a list – and it’s growing – of disparate factors which will lead to economic headwinds, and this list is both expanding and worsening. These factors will eventually derail US (and global) economic growth, and should this occur, it would be negative for risk assets and positive for USTs. Top-of-the-table risks include:
The conflict in the Middle East looks far from contained and uncertainty abounds;
The US government is continuing its dysfunctional run, especially as Republicans look more and more like incompetent muppets in the House. Assuming a speaker is eventually elected, this would return the budget impasse back to the front pages as the Nov 17 interim budget expiry looms. And did I mention the deficit (read this)?
Inflation remains stubbornly high even if the trajectory looks to be heading in the right direction. US economic data is mixed albeit skewed towards the upside; and
Higher interest rates along the entire yield curve – which work on a lagged basis – will certainly bite increasingly hard as time passes.
Long-only retail investors probably shouldn’t pile into duration just yet unless their maturity (or average life) needs are sufficiently long (and hence, matched). Investors wanting to take more risk might be increasingly tempted to extend duration at 5%+ yields. I am:
Staying short in government bonds (3mos-6mos rolling),
Remain invested (but am monitoring carefully) credit (i.e. corporate bonds), and
Am well long but skewed very defensively in my stock portfolio.
I believe the best days in equities are probably behind us, at least for the time being. There’s a lot of uncertainty on the horizon, and I struggle to see through this thickening fog to a brighter day. Maybe that’s just because it’s a grey and rainy morning here in London.
US Treasury bonds were the big mover as far as financial markets this week, as yields headed higher across the curve. Since USTs reflect the global risk-free rate, the sharp increase in yields naturally had repercussions across other asset classes, especially global equities which were generally lower.
The yield on the 10y UST increased 30 bps this week, with a series of strong economic data being the principal catalyst. The 2y-10y yield curve differential narrowed to its least negative level (-14 bps, inverted) since July 2022.
Fed Chairman Powell reminded investors during an interview on Thursday at the Economic Club of New York that:
The economy remains surprisingly strong,
As a result inflation remains challenging and is not coming down quickly enough,
Even so, Mr Powell signalled a pause in the Fed Funds rate at the November FOMC meeting although he left the door open for a possible rate rise in December should the economy remain resilient,
Conclusion is that “higher for longer” is the path forward based on current data
Yields on corporate bonds spiked this week along with UTS yields. Credit spreads are also widening, a potential harbinger of what may lay ahead for the US economy overall.
Safe haven gold continues to head higher, closing the week at $1,983/ounce, up nearly 10% since its early October low. Bitcoin is also sharply higher over the last month.
Oil prices remain under pressure as the Middle East situation remains volatile. The US Dollar was steady this week although it remains at elevated levels
Earnings were ok this week, with the focus mainly being on BofA, Goldman, Tesla and Netflix – see next section.
WHAT HAPPENED THIS WEEK THAT MATTERED?
US retail sales were stronger than expected, suggesting that the US consumer is still in a “spend mode”. Sept retail sales data was +0.7% MoM / +3.85 YoY. Census Bureau retail sales data for Sept is here
Other US data included new housing starts (Sept) and first-time jobless claims (week ended Oct 14) .
New housing starts were down sharply in Sept (Census Bureau data here).
First-time jobless claims fell below 200,000 for the week, below consensus expectations and below the prior week (DoL release here).
Chairman Powell addressed the Economic Club of New York, references in section above
UK inflation disappointed, remaining flat MoM (ONS release here), and stoking on-going concerns about “stagflation”. Inflation remains stubbornly high in the UK (highest in the G7) and there’s a long ways to go to return to the 2%/annum target, as growth sputters. UK consumer confidence also fell to the lowest level in three years according to a survey by GfK (here).
Chinese GDP (+4.9% 3Q23) and retail sales (+5.5% in Sept MoM) were better than expected, according to data from the National Bureau of Statistics from China (release here).
S&P 500 earnings were generally OK. The last two of the big six US banks reported earlier in the week, with both #BAC and #GS beating on the top and bottom lines but Goldman Sachs experiencing a sharp YoY decline in earnings. Tech giants #NFLX and #TSLA (tech giant or automotive company?) also reported, setting the stage for the "Mag 7". NFLX beat on earnings and most importantly subscriber growth, whilst Tesla delivered disappointing results. Here’s a table I published on Twitter earlier this week, to set the stage for tech earnings.
Weekly aggregate earnings update for the S&P 500 (via LSEG I/B/E/S) is here
WHAT MATTERS THIS COMING WEEK
Things to watch:
Uncertainty in the Middle East: direction of and contagion associated with the Israeli-Hamas conflict is ongoing and uncertain, heading in the wrong direction
UAW strike in the US: volatile situation / ongoing since Sept 15; affecting the “Big Three” (Ford, GM, Stellantis; Tesla not unionised); layoffs spreading, resolution seems far away still
US government remains dysfunctional: Republicans cannot choose a leader in the House. 2023-24 budget discussions resolved in early October for six weeks, but will be re-visited and must be resolved by Nov 17th. Don’t count on it. Biden adds to deficit, no fiscal restraint in sight.
Student loans are out of forbearance with payments having re-started
Carryover themes: Higher oil prices, stronger US Dollar, China growth (signs property sector is worsening, although 3Q23 growth and retail spending data positive)
Economic data: Much-watched PCE (inflation indicator, US) for September will be released on Friday. PMI data for the US and UK will be released mid-week. Japanese CPI and 3Q23 GDP for the US to be released Thursday.
Corporate earnings for 3Q23 have started. "Mag 7" (six remaining) earnings are as follows:
o Oct 24: GOOG, MSFT
o Oct 25: META
o Oct 26: AMZN
o Nov 2: AAPL
o Nov 21: NVDA
Upcoming central bank meetings:
ECB: Oct 26 (expect pause) and Dec 14
Federal Reserve (FOMC): Oct 31/Nov 1 (expect pause); Dec 12-13
Bank of Japan: Oct 30-31 (same as always) and Dec 18-19
Bank of England: Nov 2 (expect pause but most complicated) and Dec 14
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