Last Week in Review – October 16, 2023 – from Stephen Colavito
Last week, the major indexes ended mixed as investors weighed inflation data against dovish signals from Federal Reserve officials. Large-cap value stocks outperformed, helped by earnings beats from Citigroup, Wells Fargo, and JPMorgan Chase. The banking giants kicked off the unofficial start to third-quarter earnings reporting season on a positive note, as their profits got a boost from higher interest rates.
The prospect of a widening war in the Middle East following last weekend’s Hamas attacks against Israel boosted energy shares and defense stocks while weighing on airlines and cruise operators. Dialysis provider DaVita also fell sharply on reports that Novo Nordisk’s new dialysis drug, after being widely adopted to treat obesity, also demonstrated success in treating kidney disease.
The sentiment appeared to get a boost at the start of the week after Fed Vice Chair Philip Jefferson told an economics conference in Dallas that he was mindful that the rise in long-term bond yields might affect the need for future rate hikes. He also acknowledged that policymakers must " balance the risk of not having tightened enough against the risk of policy being too restrictive.”
Dallas Fed President Lorie Logan, widely considered one of the central bank’s most hawkish policymakers, also surprised some by telling another economics conference that “there may be less need to raise the fed funds rate” because of the higher yields. However, she repeated her insistence that rates would need to remain elevated.
The Wednesday release of the minutes from the Fed’s September policy meeting seemed to confirm the shift in official thinking because of higher yields. In particular, while “all agreed that rates should stay restrictive for some time,” officials also agreed that the “Fed should shift communications from how high to raise rates to how long to hold rates." By the end of the week, federal funds futures were pricing in only a 5.7% chance of a rate hike at the next Fed meeting in November versus 27.1% the previous week, according to the CME FedWatch Tool.
US - MARKETS & ECONOMY
Slightly hotter-than-expected inflation readings did not sway investor expectations for the Fed’s next move, perhaps due to expectations that officials might also weigh the added uncertainty from the war between Hamas and Israel. Last Wednesday, the Labor Department reported that core (excluding food and energy) producer prices rose 0.3% in September, a tick above expectations. The surprise 2.7% increase in year-over-year core producer prices was the highest level since May, however, due to a significant upward revision in the previous month. Core consumer price index (CPI) inflation data, released Thursday, was in line with expectations, rising 4.1% for the year ended September 30, its slowest pace in two years.
US – EQUITY MARKET PERFORMANCE
US YIELDS & BONDS
Last week, Treasury and tax-exempt municipal bond yields decreased sharply over much of the week, eased down by the Fed comments and a flight to quality following the outbreak of war in the Middle East. (Bond prices and yields move in opposite directions.) In the muni market, longer-maturity bonds benefited from healthy demand and a limited supply of favorable bond structures. Primary issuance volumes were manageable, with the deals generally experiencing strong demand.
Likewise, issuance in the investment-grade corporate bond market was front-loaded during the week, and most issues were oversubscribed. Last Thursday, issuance quieted down in anticipation of the CPI release. The high-yield bond market continued to trade well despite geopolitical headlines. Higher-quality below-investment-grade bonds performed well due to the downward move in rates. As cash balances remain healthy, there is a solid demand for new issues—especially higher-quality secured bonds. Steady demand from accounts with excess cash due to recent paydowns contributed to the firm tone in the bank loan market.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth +0.01 bps to 5.48%
2-yr: 0.00 bps to 5.05%
5-yr: +0.03 bps to 4.64%
10-yr: +0.04 bps to 4.61%
30-yr: +0.05 bps to 4.75%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index ended 0.95% higher, snapping three weeks of losses after dovish comments from Fed policymakers and reports that China was considering more economic stimulus measures. Major stock indexes were mixed. Italy’s FTSE MIB rose 1.53%, Germany’s DAX slipped 0.28%, and France’s CAC 40 Index fell 0.80%. The UK’s FTSE 100 Index added 1.41%.
European government bond yields broadly declined due to demand for safe-haven assets after last weekend’s flare-up of violence in the Middle East. However, robust U.S. inflation data cushioned the drop in yields. The benchmark 10-year German government bond yield ended near 2.75%.
The minutes of the European Central Bank’s (ECB) September meeting revealed that “a solid majority” of policymakers voted to raise the critical deposit rate to a record high of 4.0%. The decision appeared to be a close call, given the “considerable uncertainty.” Pausing the rate increases “risked being interpreted as a weakening of the ECB’s determination, especially when headline and core inflation was still above 5%,” the minutes said.
The German government joined a string of other forecasters and sharply lowered its outlook for the country’s economy this year. According to this updated view, the economy is projected to shrink by 0.4% due to higher energy prices and weaker demand from major markets like China. Estimates released in April had called for Germany’s economy to grow by 0.4%. The Economy Ministry expects economic growth to pick up at the start of next year and then accelerate amid a recovery in consumer demand.
Japan’s stock markets gained over the week, with the Nikkei 225 Index up 4.3% and the broader TOPIX Index rising 2.0%, continuing their year-to-date solid gains as historic weakness in the yen lent ongoing support. The yen weakened to around JPY 149.6 against the U.S. dollar, from about JPY 149.2 the prior week, despite seeing some support from investor demand for safe-haven currencies amid the violent developments in the Middle East. While Japanese authorities have repeatedly stressed that they would act against excess currency volatility without ruling out any options, there has been no evidence that they have recently intervened to stem the yen’s slide.
The yield on the 10-year Japanese government bond (JGB) fell to 0.76% from 0.80% at the end of the previous week. Speculation was ongoing about when the Bank of Japan (BoJ) could further normalize its monetary policy, having tweaked its yield curve control (YCC) approach in July to effectively allow yields to rise more freely but capping them at 1.0%. Asahi Noguchi, a BoJ Board member, indicated during the week that the central bank has room to maneuver before the JGB yield hits its ceiling and that there is no pressing need to alter its YCC policy.
In its October World Economic Outlook, published during the week, the International Monetary Fund (IMF) revised its forecast for Japan’s growth in 2023 to 2.0% from 1.4%. The international organization expects a range of factors—including pent-up demand, rebounding inbound tourism, accommodative monetary policy, and easing supply chain constraints boosting auto exports—to support expansion.
The IMF also lifted its forecast for Japan’s price gains, anticipating that consumer inflation will tick up 3.2% this year from a previously expected 2.7% rise. The BoJ will likely raise its inflation forecasts in October, as broader-than-expected price hikes, rising crude oil prices, and yen depreciation have exerted upward pressure on prices.
Financial markets in China declined in the first week of trading after the Golden Week holiday, as softer inflation and trade data renewed concerns that the economy may slip back into deflation. According to FactSet, Hong Kong's benchmark Hang Seng Index gained 1.87%. China’s CPI remained unchanged in September from a year earlier, following August’s 0.1% rise, primarily due to weaker food prices. Producer prices fell an above-consensus 2.5% from a year ago but eased from the 3% drop the previous month.
Meanwhile, trade and lending data came in above expectations but remained weak. Overseas exports fell 6.2% in September from a year earlier, slower than the 8.8% drop in August. Imports also shrank by 6.2%, better than the 7.3% contraction in August, marking the seventh straight month of declines. New bank loans rose to a lower-than-expected RMB 2.31 trillion in September, up from August’s 1.36 trillion. While the above-consensus results signaled that some parts of China’s economy are stabilizing, it was not enough to dispel fears about its weakening growth outlook.
Lastly, Israeli assets, especially the shekel currency, were pressured by the previous weekend’s Hamas attacks and Israel’s subsequent declaration of a state of war and an emergency across the country.
The perception of an existential threat to Israel has taken priority over the domestic political disagreements—such as far-reaching judicial reforms and other controversial legislation—that have divided the electorate the most since Prime Minister Yitzhak Rabin was assassinated in November 1995. Israel’s leaders have agreed to form a narrow emergency government that will include the current government coalition (Likud and Right of Center parties) and the opposition National Unity party. Notably, the government has agreed that no resolutions will be advanced through the Knesset legislature during the war unrelated to managing the war. This underscores the importance of social and financial stability that needs to be ensured by major Israeli institutions, including the Bank of Israel and the Ministry of Finance.
Concerning Israel’s fiscal situation, the outlook, which had been supportive, has turned more neutral and is likely to worsen, given the probable increase in military spending. We anticipate that the 2023 budget deficit will likely widen to and above 2.0% of GDP versus a target of 1.2%. He also projects that there will be a 2024 budget deficit of about 1.4%. These deficits would follow a year of a budget surplus of 0.6% in 2022 and a shortage of 4.3% in 2021.
THE WEEK AHEAD
This week, investors will closely monitor key speeches by several Federal Reserve policymakers to assess the potential trajectory of monetary policy in the coming months. Simultaneously, the third-quarter earnings season is in full swing, with anticipated reports from major companies, including Bank of America, Goldman Sachs, American Express, Morgan Stanley, Johnson & Johnson, Procter & Gamble, Netflix, Tesla, AT&T, Blackstone, Philip Morris International, Taiwan Semiconductor Manufacturing, Intuitive Surgical, and SLB. Regarding economic data, retail sales in September are expected to have grown by 0.2% last month, a slight slowdown from the 0.6% increase in August. Industrial production is also noteworthy, with anticipated growth of 0.1%, down from the 0.4% recorded in the previous period. The housing sector will also be scrutinized, focusing on building permits, housing starts, and existing home sales. Additional data includes business inventories, overall capital flows, the NAHB Housing Market Index, the NY Empire State Manufacturing Index, and the Philadelphia Fed Manufacturing Index.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
This message is informational and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. San Blas Advisory is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, available upon request.