Week in Review
The highlight of the past week was clearly the surge in US bond yields which helped drag down equity prices to a degree. Having broken through previous year highs at 3.10%, the dam wall burst and quickly pushed US 10-year bond yields to 3.24% – on the back of ongoing strong US economic data and seemingly hawkish comments from Fed chairman Powell.
The bond sell-off began on Wednesday following a jump in the US ISM non-manufacturing index from an already strong 58.5 to a blistering 61.6. There followed a strong ADP payrolls report (a precursor to the official payrolls report) and then a speech from Fed chairman Powell, in which he suggested rates were still well below neutral and might need “to go past neutral” at some stage.
As it turned out, Friday’s headline payrolls gain was a bit weaker than market expectations, but still solid nonetheless – especially given the negative effect of recent hurricanes and large upward revisions to employment in previous months. Meanwhile, the unemployment rate ticked down to 3.7% – its lowest level since 1969! Annual growth in average hourly earnings remained firm at 2.8%, but down from the previous month’s 2.9% and so failed to show the further acceleration that many (including myself) were fearing.
The surge in US bond yields was only partly reflected in higher local yields, with the further squeeze in interest-rate differentials crushing the $A, leaving it hovering at just over US70c. A weaker $A, in turn, appears to be providing some support to local stocks, which held up modestly better than Wall Street last week.
What to make of all this? To some extent, the surge in US bond yields appears a technical move – following a break of a key previous high – and my sense is that the market has also over reacted to Powell’s comments. It would not surprise if US 10-year bond yields now spend some time consolidating above 3% rather than continuing to surge further. Of course, this view is based on US wage and price inflation remaining fairly contained for some while longer. As regards equity markets, moreover, note higher interest rates have been dragging down global PE valuations for some time, but this has – so far at least – been more than offset by strong growth in earnings. This still remains my base case for the next 3 to 6 six months at least.
In other news, Italy’s budget battle continues to pose concerns in Europe while China eased credit conditions somewhat further over the weekend to help bolster its economy in the face of US tariff increases. The latter is consistent with my view that China is “hunkering down” – preparing to endure US tariffs rather than be forced into negotiating far-reaching trade concessions anytime soon. That leaves the ball in Trump’s court, as he has threatened to jack up tariffs to 25% (from 10%) in January next year.
There’s only a smattering of key market events to focus on in the week ahead, with the US CPI on Thursday the likely highlight give the market’s increasing sensitivity to US inflation. Chances are, however, that the CPI will remain relatively benign, showing core inflation hovering just where the Fed wants it at just over 2%. In Australia, the NAB business survey is released tomorrow, and should show business sentiment remains fairly upbeat.
Have a Great Week!