Muzinich Weekly Market Comment: Fight Night!

November 11, 2024

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In our latest roundup of the key developments in financial markets and economies, we explore the widening gulf between governments and central banks. 

As he might himself say, US President-elect Donald Trump will be tremendously pleased – not only by the scale of victory for his Republican Party, which seems set for a red sweep, but also by the immediate reaction in financial markets. This is one of his key indicators for evaluating policy success, as demonstrated during his first term.

Government bond yields remained unchanged or slightly lower across the curve. Corporate credit spreads tightened, contributing to positive returns across markets, with US high yield the pick for the week.

In FX, the US dollar showed little change relative to other G10 currencies. The bigger trend was a weakening euro across the board. In contrast, emerging market (EM) currencies performed well, with commodity currencies such as the South African rand, Brazilian real and Mexican peso each appreciating by over 2% against the US dollar. Currencies tied to manufacturing in Asia depreciated slightly, but by less than 0.5%.

Except for gold, commodities had a strong week, as did digital currencies. US equities surged, the S&P 500 climbing over 4%, while the Bloomberg World Index rose more than 3% and the Shanghai Index was up by over 5%. Europe was the underperformer.

After recent spikes, volatility mean reverted, with both the VIX (equity volatility)^[1] and MOVE (bond volatility)^[2] moving back to their one-year averages.

China feels the force

Chinese assets had a strong week, bolstered by confirmation of additional government measures aimed at boosting growth. The National People’s Congress Standing Committee approved a 10 trillion-yuan (US$1.4 trillion) package to help local authorities bring off-balance-sheet debt onto their books.^[3]

This is just the beginning, with Finance Minister Lan Fo’an stating that “more forceful” fiscal policies will be introduced next year, hinting at measures directly targeting the housing market, bank capital and domestic consumption.^[4] The next major opportunity to announce further stimulus measures will come in December during the annual Central Economic Work Conference, when the 24-member Politburo and policymakers meet.

Bank of England delivers

The Bank of England cut its benchmark rate from 5% to 4.75%, as expected.^[5] The vote of its Monetary Policy Committee was split 8-1, with Catherine Mann the lone voice in favour of keeping rates unchanged. The Committee maintained its guidance from the September meeting, reiterating that a “gradual approach to removing policy restraint remains appropriate.”

The Committee did, however, revise its economic forecasts upward.^[6] This adjustment, as shown in our Chart of the Week, reflects the significant policy easing embedded in the government’s fiscal plans.

As a result, inflation is now expected to remain above target until 2027, while neutral policy rates are projected to be reached by Q4 2025, somewhere around 3.6% to 3.7%. The overnight interest rate one-year forward stands at 4.05%,^[7] suggesting investors are more concerned about potential inflationary pressures stemming from the government’s fiscal plans.

Germany snaps

The European Central Bank does not meet until December, so attention shifted to Germany, albeit for troubling reasons that did not support asset prices. German Chancellor Olaf Scholz dissolved his three-party ruling coalition by dismissing FDP Finance Minister Christian Lindner, known for his staunch fiscal conservatism.^[8]

Tensions within the coalition had been rising over next year’s budget and strategies for reviving Germany’s sluggish economy. Lindner’s refusal to lift limits on additional borrowing may have been the breaking point for the Chancellor.

As a result, Chancellor Scholz now heads a government without a majority in the Lower House of Parliament, raising the possibility of snap elections as early as January. This development compounds uncertainty in the Eurozone, especially given that France, its second-largest economy, has a fragile parliament and worsening fiscal conditions. Recently, both Moody’s and Fitch downgraded their outlook for France.

Moody’s stated: “The decision to change the outlook to negative from stable reflects the increasing risk that France’s government will be unable to implement measures preventing sustained, wider-than-expected budget deficits and deteriorating debt affordability.”^[9]

With political fragility, sluggish economic growth and broader geopolitical uncertainty, it is perhaps unsurprising that European markets underperformed last week.

Fed unanimous

The Federal Reserve’s Federal Open Market Committee (FOMC) unanimously lowered its rate target by 25 basis points (bps) to a range of 4.50%-4.75%.^[10] Fed Governor Michelle Bowman, the sole dissenting voice against the 50bps cut at the September meeting, supported the smaller cut this month.

The most notable change in the Fed’s policy statement was the removal of the phrase indicating the FOMC “has gained greater confidence that inflation is moving sustainably toward 2 percent”. This change could be interpreted as the FOMC being less confident about the disinflation trajectory under the next administration.

During the accompanying press conference, Federal Reserve Chair Jerome Powell stated he would not resign if asked to do so by Trump. He also emphasized that the removal or demotion of any Fed board leaders, including himself, is not permitted under law.^[11]

Inflation: Down, but for how long?

Stepping away from the weekly news, it seems increasingly apparent that government policies in advanced economies are heading in an inflationary direction. Examples include France’s reluctance to rein in fiscal spending, the UK’s autumn budget, Chancellor Scholz's dismissal of his finance minister over resistance to lifting borrowing limits, and President-elect Trump’s campaign, which focused on deportation, increased tariffs, tax cuts and deregulation.

Central bankers will remain reactionary, continuing to emphasise their approach to rate decisions will be “data dependent”. But the warning signs are there for all to see, with projection upgrades and changes in the language of policy statements.

As far as 2025 is concerned, governments and central banks objectives do not seem aligned, in our view. They are at the opposite sides of the ring - let the fight begin!

Chart of the week: Bank of England lifts inflation forecasts

Forecasts mentioned are not a reliable indicator of future results.

Source: Bank of England, Forecast Summary, as of November 7, 2024. Numbers in brackets were previous forecasts as of August 2024. For illustrative purposes only.

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

References

[1] Cboe Global Markets, VIX Index, as of November 8, 2024
[2] ICE BofA Platform, MOVE Index, as of November 8, 2024
[3] China Daily, ‘China's top legislature concludes standing committee session,’ November 8, 2024
[4] Bloomberg, ‘China Unveils $1.4 Trillion Debt Swap, Saves Stimulus for Trump,’ November 8, 2024
[5] Bank of England, ‘Bank Rate reduced to 4.75% - November 2024,’ November 7, 2024
[6] Bank of England, ‘Monetary Policy Report - November 2024,’ November 7, 2024
[7] Bloomberg, Market Implied Interest Rate, as of November 8, 2024
[8] BBC News, ‘German coalition collapses after Scholz fires key minister,’ November 6, 2024
[9] Moody’s Ratings, ‘Moody's Ratings changes France's outlook to negative from stable, affirms Aa2 rating,’ October 25, 2024
[10] Federal Reserve, ‘Federal Reserve issues FOMC statement,’ November 7, 2024
[11] Federal Reserve, ‘FOMC press conference,’ November 7, 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 November 11, 2024, and may change without notice. All data figures are from Bloomberg, as of November 8, 2024, unless otherwise stated.

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