It has been quite the week in financial markets, wrapping up a month that saw financial conditions ease drastically as an “everything rally” took hold – easily one for the history books. The “higher-rates-for-longer” narrative evaporated quickly, as a one-two punch from unusually dovish Fed Governor Waller and soft Spanish and Germany inflation figures on Tuesday reinvigorated bond bulls, who amid frenzied buying pushed key interest rate benchmarks through major technical levels. Other central bank speakers’ attempts at pushing back against the rapid pricing of additional rate cuts failed to convince market participants, who called their bluff by instead pricing in an additional ~50bp of rate cuts in USD and EUR. As if adding further insult to injury, a small chance (5%) of a rate cut is now priced into this month’s European Central Bank meeting scheduled 2 weeks from now.
Further aided by the confluence of accommodative seasonality and momentum chasing, this development emboldened risk assets and precious metals to the detriment of the US dollar, which fell against nearly every major currency except the EUR, itself weighed down by an even more rapid pace of rate cuts priced and a darkening economic outlook in the Eurozone. While a pullback seems increasingly likely given the velocity of recent moves, it will be hard to shake the disinflation-driven easing narrative now deeply entrenched into market pricing (try as they might, central bankers). The pain trade in risk assets is still to the upside, and the tail risk of a late 1999-esque NASDAQ “melt-up” is now non-negligible. Concurrently, any upside surprises in upcoming inflation prints can quickly turn the complacency-fuelled disinflation narrative on its head and a sharp market reversal could ensue.
This week amplified the ongoing bifurcation of US and Chinese equity markets – US equity indices continued their push toward YTD highs while Chinese markets languished in the red. The old playbook of fading any stimulus-driven pop higher in Chinese equities maintained its relevance this week, as both the CSI300 and Hang Seng slid toward October lows amid pessimism on the myriad of economic problems and the continued lack of “bazooka” stimulus measures sought by the market, after an attempted move higher last week on back of news that Chinese regulators cleared a list of real estate firms to tap cheap financing.
US tech stocks lagged their cyclical and small-cap peers this week – rightfully so as cyclical names are potentially the biggest beneficiary of an easing cycle. The fact that the rest of the market lagged the Magnificent 7’s performance this year is well understood, and this week saw emphatic price action toward reversing this trend. The Equal-Weight SPX vs SPX ratio (proxied by the RSP/SPY ETFs) encapsulates this reversion, while persistence of the soft-landing/no-landing narrative leads one to wonder if this shift sets up for a cyclical rally/outperformance in 2024.
Over in commodities, WTI oil failed to push above $80 in the aftermath of OPEC+'s 1m barrel-per-day output cut and ended the week 1.9% lower, with the market clearly unimpressed by the lack of detail on distribution of output reduction among members states. Conversely, things were upbeat in precious metals with spot gold building on its recent winning streak to hit a new YTD high on Friday – no doubt the biggest beneficiary of a weak USD and rapid decline in front-end interest rates, with the stockpiling of gold by global central banks another major tailwind.
The mood in cryptocurrencies was fairly upbeat with many major crypto assets advancing. Bitcoin notched a new YTD high after successfully clearing resistance at $38,000 on Friday, paving the way for a challenge of the $40,000 psychological level in December. Ethereum initially lagged the mothership as the $2100 level proved a tough nut to crack, although it managed to clear this hurdle over the weekend.
The ferocious rally in Fixed Income amid disinflation excitement saw almost 2 additional 25bp Fed rate cuts now priced for 2024, and a total of close to 200bp of cuts now priced for the upcoming easing cycle. Major yield curves generally bull steepened on the front-end led rally. Over in Credit, spreads continued to tighten alongside the rally in risk assets.
Ultimately, this week (and November by extension) was a stark reminder that financial markets turn on a time and often take no prisoners. In the space of barely more than a month, the narrative took a drastic 180-degree turn from higher-for-longer to full on disinflation, almost to the point of complacency. A litany of central bank decisions are due in mid-Dec (Federal Reserve, European Central Bank, Bank of Japan etc.) before markets slowly wind down into year-end, offering one final chance this year for policymakers to push back on cuts pricing and make clear their stance on the rapid easing of financial conditions. Barring data surprises, one suspects that the market will force their hand to deliver on rate cuts in 1H2024 (except the BoJ), rather than in 2H2024 as initially envisaged by many participants.
More thoughts on the market to follow (hopefully).
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