Investors were on a roller-coaster this week. Stocks rebounded early this week while quickly declined afterward. It was mainly driven by the false hope of the Fed’s favorable reaction to the economic data. The benchmark index has averaged above 1% daily swing in the last 40 weeks. Other than equities, volatility has also whipped up across other asset classes. Under the current environment, the good news is bad news as positive economic data like strong US services data will raise the odds of continuous rate hikes. Although the US ISM manufacturing PMI, new orders PMI and job openings are lower than expected, markets believe that will not trigger a Fed pivot and are still pessimistic about the equity markets. Non-manufacturing PMI in China reported below consensus, which is detrimental to risky assets.
OPEC+: Oil futures gained more than 10% this week after OPEC+ announcement of its largest production quota cut since 2020 - 2 million barrels per day, which is higher than the initial expectation from the market. It is notable that the cut here is "production quota" but not "production" cut, which means there is not an exact 2 million barrels off the market. By analyzing members of OPEC+ individually, an 800k barrels production cut is expected if they follow strictly what they have announced. Nevertheless, the intention of OPEC+ is clear - they want to defend the oil price. Thus, the signal is bullish.
UK U-turn: Truss ditched her tax cut plan after it dragged the pound to all-time low and triggered market turmoil. The pound rebounded after the reversal news, and returned to the level before the tax cut announcement. The tax cut plan was described as “Reverse Robin Hood” which reduced the tax rate of the higher income groups.
MBS: The increasing mortgage rates have destroyed assets that are linked with new home buying and mortgage origination. Fed’s tightening is also an overhang on the Mortgage-Backed Securities (MBS) market. MBS spread has widened to around 3 standard deviations above the average in the last decade.
Central Bankers: Reserve Bank of Australia (RBA) hiked rates by 25bps, lower than the market expectations of 50bps. Reserve Bank of New Zealand (RBNZ) hiked rates by 50bps, aligned with consensus. European Central Bank (ECB) minutes implied the board's support for a 75bps hike in the coming meeting. Fed reiterated the need for continuous rate hikes to achieve its inflation target.
Jobs Market: The growth is slowing down in the jobs market while the unemployment rate is dropping. Nonfarm payroll data reported higher-than-expected jobs in September. Investors are expecting the Fed will continue its tightening and another 75bps hike is more likely to happen in the meeting next month.
*Data as of market close. 5-day change ending on Friday.
VIEW FROM THE STREET
Morgan Stanley: The policy-driven bear markets lead to a reset of valuation multiples that are based on the increase of cost of capital. There will probably be a downgrade of corporate earnings as well due to slow growth.
J.P. Morgan: US equities were struggling in the last quarter due to deterioration in valuation multiples with the drop in earnings expectation that led to negative returns. Equities in the developed market (DM) and emerging market (EM) dropped 9.3% and 11.4% respectively. For DM, European is facing high energy costs and policy changes in the UK. For EM, rising inflation is happening across regions, and concerns about economic growth in China.
Citi: Equity bear market is not a straight way down as there could be short covering rallies along the way. In terms of seasonality, equities tend to perform better in the 4th quarter compared to other quarters. Also, the required returns for taking equity risk are higher when other less risky alternatives like bonds are yielding high.
Morgan Stanley: Both 2Y and 10Y Treasury yields nearly reach record increases. The 2Y yield is at 4.22%, its highest since 2007. IG corporate bonds with short duration have a nominal yield higher than 5%, which is the highest in a decade. Although there is a risk of wider spread, it could be offset by the capital appreciation due to the economic slowdown and rates rollover next year. J.P. Morgan: Global high yield declined in 3rd quarter due to the combination of rate hikes and concerns of policy error that lead us to recession. Although the credit quality seems stable, credit risks could rise because of the slower growth, stick inflation, and high rates environment.
Standard Chartered: With the expectation of further rate hikes, bond yield risk is expected to be skewed to the upside. The 10Y Treasury yield is expected to test 4% by the end of the year. Given the softening bond yield recently, it is suggested to look for opportunities in IG corporate bonds and Asia USD bonds instead of government bonds.
Citi: Historically, an economic downturn lasts 11 months on average. The equity market typically reached its bottom halfway through the recession period. Considering the policy lags between Fed’s tightening and economic downturn, equities could trade below this year’s lows in the first few months of the coming year.
Standard Chartered: It is still too soon to talk about the Fed pivot in the policy. Markets were hoping there would be a peak in rates after the weak job openings and US manufacturing data. The hope faded away when central bankers from various countries reiterated the need of bringing inflation down to their targets.
Bank of America: The massive stimulus recently is similar to the World War II stimulus in terms of duration and magnitude. With that as a reference, inflation is expected to peak in 2022 with a recession in 2023, and a possible deflation in 2024 if the Fed sticks to its current tightening plan.
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