November market update: Re-evaluation of market’s expectations
United States | China | Australia | Outlook
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The key theme in October was a significant re-evaluation of the market’s expectations for US official interest rate cuts, driven by ongoing robust US economic data and rising expectations of a Trump Presidential victory.
Over the past month US and Australian interest rate markets experienced a sharp sell-off with market yields in both countries rising by around 0.5% as investors significantly re-priced their expectations for the size and timing of future interest rate cuts. Market participants now expect fewer rate cuts, occurring later, in both countries.
Continued stronger-than-expected data releases drove these market moves as did increasing expectations of a Trump presidential victory (with Trump’s policies regarded as pro-growth and inflationary by investors).
Over the month US 10-year and two-year yields both rose by around 0.50% (in a near parallel fashion). The Australian 10-year yield rose by 0.50% while the 2-year yield increased by 0.40%, so causing the Australian yield curve to “steepen”. Yields in almost all other developed markets rose as well, but by significantly less than what was experienced in the US and Australia.
Global equity markets recorded modest moves over the month, with all the action focussed on bond markets in October. Moves in currency markets reflected the resiliency of the US economy with the US dollar (USD) rising against all key currencies. The strength of the upside surprise in US economic data outpaced that witnessed in Australian data and caused the USD rise against the Australian dollar (AUD) over the month as well.
In this market update we look at:
- Positive economic surprises in the US and Australia in October and what drove the significant re-pricing of US rate cut expectations.
- The market impact of rising expectations of a Trump Presidential victory.
- Continued weakness in Chinese economic data and speculation that further policy adjustments may be coming.
- Australian economic conditions – particularly strength in the labour market – which are keeping the RBA on the rate-cut sidelines.
- Consumer-related company profit downgrades.
As noted in recent monthlies, we remain optimistic but cautious about the market outlook and, while we expect a modest consolidation of recent equity market moves, at this stage the macroeconomic catalysts for a significant equity market selloff are not present.
However, were market interest rates to continue rising at the pace they have in October (which we do not expect) there will likely be increased pressure on equity market valuations – the relatively high valuations currently exhibited in many global equity markets would not be compatible with continued increases in bond yields.
| United States
Global economic surprises turned more positive in October
Observed most clearly in the US, ”surprises” in global economic statistics turned markedly more positive in October. This was especially the case in the US and Australia (as we will cover in this October market update), but also in the UK.
Global Economic Surprise Index
Source: Goldman Sachs
Falls in market interest rates in September in the US were reversed in October, especially following the strong September US payroll outcome
The US Central Bank’s policy-making committee (FOMC) decided to lower the target range for the key federal funds rate by 0.5% (to a range of 4.75% to 5%) on 18 September. This was a larger cut than some had expected at the time and contributed in the following days to a fall in US two-year bond yields to 3.50% and 10-year yields to around 3.70%.
However, since that time especially after the release of the September jobs report on 4 October, two-year yields have rebounded by around 0.55% (to 4.17%) and 10-year yields by around 0.55% (to 4.28%). The increase in the 10-year yield over the past month has been one of the largest since the global financial crisis.
This move higher by yields is entirely consistent with the strong run of macroeconomic data following what is increasingly appearing to be an overdone rate cut of -50bps by the FOMC in September. Reflecting this change in sentiment, the near-term pricing in the futures market is now looking for only 1.5 rate cuts of 0.25% by year-end whereas, prior to the jobs report, two cuts totalling 0.50% were priced.
The US September payroll release revealed that total non-farm payroll employment increased by 254,000, higher than the average monthly gain of 203,000 over the prior 12 months. Also pointing to strength in the labour market were upward revisions to earlier estimates for employment growth in both July and August. Also pointing to resiliency in the US labour market was the unemployment rate which drifted slightly lower to 4.1% in September, from 4.2% in August and a recent peak of 4.3% in July.
US monthly payroll growth (September 2022 – September 2024
Source: US Bureau of Statistics, The Employment Situation – September 2024, released 4 October 2024
Other measures of the US employment market are also indicative of ongoing strength, with the steady state of the weekly total of worker claims for unemployment insurance suggesting labour market conditions remain solid.
Initial claims for unemployment insurance
(October 2023 – October 2024)
Source: FRED Economic Data, St Louis Fed, Unemployment Insurance Weekly Claims Report, released 24 October 2024
A string of solid US data and increasing expectations of a Trump presidential victory driving yields higher
As well as the September employment report and the steady picture portrayed by initial claims, the latest US inflation report was also consistent with downward revisions by investors regarding the number and size of future rate cuts.
In September the US Consumer Price Index (CPI) rose by 0.2% for the third consecutive month while the core rate rose by 0.3% for the second consecutive month. This pattern has caused the annual rate of growth in the core inflation rate to start increasing again.
Annual percentage change in the Consumer Price Index
Source: Bureau of Labor Statistics, US Department of Labor, Consumer Price Index – September 2024, released 10 October 2024
As the end of the month drew closer, betting markets began to price the rising probability of not only a Trump presidential victory, but also a Republican “sweep” of both the Senate and House of Representatives.
Two of the consensus trades in response to a possible Republican sweep were witnessed in October – a stronger US dollar and higher Treasury yields.
The rationale seems to be that Trump’s mooted corporate tax cuts will lead to initially higher federal budget deficits, before spurring stronger growth that increases future corporate tax receipts.
Tax cuts and tariffs are expected to lead to higher inflationary pressures in 2025 all-else equal.
Prediction Markets: Presidential election winner 2024
Source: Polymarket
One interesting dynamic this month that tends to support the Trump/inflation thesis is internal bond market dynamics – specifically the so-called “break-even” inflation rate (the yield differential between conventional (nominal) bond yields and “inflation-protected” bond yields). This measure of inflation expectations showed a marked increase during the month.
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| China
Chinese economic statistics remain generally weak
After a huge move in September when the mainland Chinese equity market (CSI) rose 21% following the surprise announcement of policy stimulus measures by Chinese authorities, the announcement of several more (minor) measures in October failed to excite investors and the CSI ended the month lower.
Although some Chinese economic reports were better than expected (feared) during the month, most reports still pointed to ongoing weakness.
The latest report on industrial profits in China pointed to further weakening in trading conditions. In annual terms, China’s industrial profits fell sharply by 28.1% in September compared with a fall of -16.7% in August. NBS (China’s statistical body) attributed the sharp falls to muted domestic demand and a continued decline in the prices of industrial products.
Chinese Industrial Profits
Source: NBS, Goldman Sachs
Chinese international trade data also paints a softening picture with annual export growth in September of just 2.4% compared with 8.7% in August. Annual import growth slowed to 0.3% from 0.5% in August.
Perhaps in response to these ongoing reports of weakness, toward the end of the month there were reports that the Standing Committee of the National People’s Congress (NPC) will approve a plan on 4-8 November to ‘bail out’ local governments across the country whereby the central government will assume local government obligations.
It is possible that if Trump were to win and seek to impose tariffs on Chinese exports that Chinese authorities would be even more forthcoming with stimulus measures.
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| Australia
Australian employment and inflation data keeps the Reserve Bank on the sidelines
Australian employment data remains robust and quarterly inflation data was not far enough away from expectations to give the Reserve Bank of Australia (RBA) a catalyst for any near-term official interest rate cuts.
In yet another upside surprise, the Australian Bureau of Statistics (ABS) reported that the unemployment rate was steady at 4.1% in September as the number of people employed rose by around 64,000 and the number of people unemployed fell by around 9,000.
Employment has risen by 3.1% in the past year, growing faster than the civilian population growth of 2.5%. This has contributed to the increase in the participation rate (the percentage of people in the working-age population that are in the labour force, i.e. either working or unemployed.
According to the ABS,
“the record high level of the … participation rate shows that there are still large numbers of people entering the labour force and finding work in a range of industries, as job vacancies continue to remain above pre-pandemic levels”.
Annual movement (%) in key CPI metrics
Source: Australian Bureau of Statistics, Labour Force – September 2024, released 17 October 2024
Reported at a level broadly in line with expectations, CPI data for the September quarter didn’t provide a catalyst for the RBA to change their view of no near-term rate cuts.
The CPI rose 0.2% in the September quarter and 2.8% annually. This is the lowest annual inflation rate since the March 2021 quarter and down from 3.8% in the June quarter. The quarterly rise was the lowest outcome since the June 2020 quarter fall which occurred during the COVID-19 outbreak.
Despite this encouraging news with the “headline” CPI outcomes, underlying CPI measures remain stickier in their rate of slowing and are not yet growing at a rate slow enough for the RBA to contemplate rate cuts:
- Trimmed mean annual inflation was 3.5%, down from 4.0% in the June quarter.
- Weighted median annual inflation was 3.8%, down from 4.2%.
- Annual services inflation was 4.6% in the September quarter, up from 4.5% in the June quarter (driven by higher prices for rents, insurance, and childcare).
Company commentary in the October market noted consumer-related weakness
October witnessed scattered commentary noting weakness in areas such as consumer spending:
- Furniture retailer Nick Scali noted a “cautious consumer” and freight costs negatively impacting margins.
- Woolworths provided a disappointing sales update late in the month, saying that
“customers remain highly value-conscious and continue to purchase more items on special or trade down to lower priced items including Own Brand”.
Travel-related companies also provided downbeat commentary over the month with Flight Centre announcing a weaker-than-expected trading update and Webjet providing weaker-than-expected news on revenue and margins.
Looking to November, the major banks will be reporting trading updates. Their commentary will be carefully examined by investors for any hints regarding the underlying strength of economic conditions, especially household spending/saving trends.
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| Outlook
With equity markets at or around record highs, we are cautious about the outlook, but not bearish.
Markets are expecting the US Fed to cut rates several more times in the next six months (although expectations have been watered down considerably).
Similarly, it appears that hopes for an early RBA rate cut are now dashed (until there is a downturn in employment or CPI measures). However, it still seems most likely that the next move by the RBA will be to cut rates.
A rate cut cycle is usually positive for equity markets, especially cyclical and small cap equities, and the relative performance of these sectors will be a good indication of the market’s expectation regarding the likelihood of a “soft” economic landing.
We remain optimistic but cautious about the market outlook, and while we expect a modest consolidation of recent moves, at this stage, the catalysts for a significant selloff are not present – there are still no clear signs in the US of excesses in inventory levels, leverage, and investment; and wage growth is moderating (albeit slowly).
Presently, the probability of a soft landing seems reasonable in the US with the Fed having now embarked on a rate cut cycle at a point that seems relatively early in the slowdown phase.
The probability of a soft landing in Australia will be determined in large part by how swiftly the RBA begins cutting rates. This is why it is important for employment and inflation data to ease in coming months.
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