Muzinich Weekly Market Comment: Still dancing

October 14, 2024

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It may have been a poor week for bond markets, but the party is still going strong in the US stock market.

It was another messy week for investors. Bond markets offered little opportunity for profit. Government bond curves continued to bear steepen, as 2-year yields rose less than 10-year yields, while corporate credit markets posted negative total returns.

Commodity markets did not fare much better. Energy prices remained flat, while metal prices fell across the board. The US dollar stood out in the FX market, appreciating against most other major currencies. Global equities bucked the trend by edging higher, with technology focused indexes outperforming.

From triumph to (PR) disaster

The week got off to disappointing start after a press conference by China’s National Development and Reform Commission (NDRC) chairman Zheng Shanjie.^[1] After the positive reaction to the announcement of monetary stimulus and support for the property and financial markets last month,^[2] there were high hopes that Zheng would announce something similar on the fiscal side, targeting domestic consumption and demand.

However, at the briefing, the NDRC announced a modest 200 billion yuan (US$28 billion) of spending to be advanced from next year. This triggered the Hang Seng equity market’s worst daily drop since the global financial crisis in 2008.

The NDRC press conference can only be described as a public relations misstep. Attention now turns to the Ministry of Finance, which is expected to announce new fiscal stimulus measures in the coming days. Analysts expect Beijing to announce a fiscal stimulus package worth around two trillion yuan to help pull the economy out of its deflationary slump.^[3]

Mixed inflation picture

Last week’s calendar of economic data was relatively light, with US consumer prices the main talking point. September's report offered mixed signals. The positive news came from a continued disinflation trend in rents, with primary rents and owners' equivalent rent (OER) inflation slowing to 0.3%, compared to previous increases of 0.4% and 0.5%, respectively.^[4] However, this was offset by rising costs in transportation services — specifically air fares, car insurance, and repairs — pushing core consumer prices up by 0.3%, slightly above the expected 0.2%. This increase brought the 12-month core inflation rate to 3.3%, up from 3.2% in August.

September was the first month since March when both payrolls and core consumer prices exceeded expectations, raising the question of whether economists have been too optimistic about the soft-landing scenario.

Throughout the week, investors shifted away from concerns about a hard landing, leaning instead toward the possibility of no landing at all. However, the latest data suggests a soft landing is still the most likely outcome.

The Federal Reserve released the September minutes of the Federal Open Market Committee meeting, revealing some members favoured a 25-basis points (bps) rate cut rather than the 50bps that was eventually announced.^[5] They suggested future cuts should follow a gradual path to allow policymakers time to assess the level of policy restrictiveness.

Call me

In politics, there was plenty of attention on the call between President Biden and Israeli Prime Minister Netanyahu, believed to be their first since August. The White House described the conversation as “direct” and “productive”.^[6]

On the domestic front, it was a strong week for the Republican campaign, with some polls now showing a 53% likelihood of Donald Trump winning next month’s election.^[7] This marks the first time Trump has led in the polls since Kamala Harris was named the Democratic candidate.

Meanwhile, the nonpartisan Committee for a Responsible Federal Budget warned a Harris presidency could increase US national debt by US$3.5 trillion over 10 years, despite her campaign’s commitment to fiscal responsibility.^[8] By comparison, Trump’s proposals could increase debt by between US$7.5 trillion and US$15.2 trillion, although he claims strong economic growth would mitigate deficit concerns.

Let’s face the music….

With the Fed focused on normalizing interest rates and both US election candidates planning to avoid austerity, the path of least resistance for the Treasuries curve is likely to be one of continued steepening. Notably, the 10-year average yield difference between 2-year and 30-year Treasuries is currently 96bps, compared to today’s difference of 43bps (see Charts of the week).

Logically, an increase in debt should lead to higher funding costs, ultimately resulting in further monetization^[9] and asset price inflation. This may help explain record equity valuations, as Figure 2 shows.

However, investors may want to remind themselves of the famous — or perhaps more accurately, infamous — comment about leverage in the financial system by former Citigroup CEO Chuck Prince.

Speaking to the Financial Times in July 2007, just prior to the start of the global financial crisis, Prince said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.”^[10]

Charts of the week:

Figure 1: US yield curve has room to steepen

Source: Federal Reserve Bank of St. Louis, Market yield on US Treasury securities at 2-year and 30-year constant maturity, October 10, 2024. For illustrative purposes only. Index used represents best proxy for US equity market.

Figure 2: Music still plays for US equities, despite record debt

Sources: US Treasury, US public debt outstanding, Federal Reserve Bank of St. Louis, S&P 500 data, as of October 11, 2024. Index performance is for illustrative purposes only. You cannot invest directly in an index, which also does not take into account trading commissions or costs. Additionally, indices do not include reinvestment of dividends and the volatility of indices may be materially different over time.

Past performance is not a reliable indicator of current or future results.

References

[1] Bloomberg, ‘China Markets warn Xi more stimulus needed to fuel rally,’ October 8, 2024
[2] Muzinich Weekly Market Comment: China seeks a spark, September 30, 2024
[3] Bloomberg, ‘China investors expect $283 billion of new stimulus this weekend,’ October 10, 2024
[4] US Bureau of Labor Statistics, ‘Consumer Price Index Summary,’ October 10, 2024
[5] Federal Reserve, ‘Minutes of the Federal Open Market Committee, September 17-18, 2024,’ October 9, 2024
[6] The White House, ‘Readout of President Joe Biden’s Call with Prime Minister Netanyahu of Israel,’ October 9, 2024
[7] PredictIt, ‘Who will win the 2024 US presidential election?’ October 11, 2024
[8] Committee for a Responsible Federal Budget, ‘The Fiscal Impact of the Harris and Trump Campaign Plans,’ October 4, 2024
[9] Monetization refers to a government converting its debt into currency. This happens when a central bank buys government bonds and finances spending through printing more money.
[10] Financial Times, ‘Citigroup chief stays bullish on buy-outs,” July 9, 2024

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies is for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of October 14, 2024, and may change without notice. All data figures are from Bloomberg, as of October 11, 2024, unless otherwise stated.

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