Issue #39: Sep'24 week 39

Block 1. Key Indices/Instruments

Block 2. U.S. macroeconomic landscape

During the week, US broad market indices experienced moderate growth, with the Magnificent-7 stocks leading the charge. Following the Federal Reserve's meeting on September 18, the S&P 500 reached a new all-time high, while the equal-weighted S&P 500 slightly outperformed its market-cap-weighted counterpart. Investor sentiment remains bullish and market statistics* acts as a headwind for a further growth. September is traditionally a weaker month for equities. Despite this, all major indices posted gains by the end of the month.

In the bond market, yields increased, particularly on shorter-term bonds, as investor expectations shifted towards a potential 25 bps rate cut at the next Federal Reserve meeting on November 7. Currently, the probability of this rate cut** stands at 65%.

In terms of macroeconomic data, the third revision of Q2 US GDP showed growth of 3%, surpassing analyst expectations of a 2.9% revision. However, personal consumption was revised down from 2.9% to 2.8%, but this had little impact on market dynamics, as GDP is a lagging indicator.

More attention was given to the release of the Personal Consumption Expenditures (PCE) price index, the Federal Reserve’s preferred inflation gauge. The annual PCE inflation rate declined from 2.5% to 2.2%, slightly better than the expected 2.3%. Meanwhile, core PCE inflation rose from 2.6% to 2.7% year-on-year but dipped from 0.2% to 0.1% on a monthly basis.

When analysing the components of the PCE, food prices showed a slight decline in their contribution, while spending on services remained relatively stable. The most significant factor driving the 2.2% figure was a decrease in fuel expenditures (Gasoline and Other Energy Goods), which deepened its deflationary contribution from -0.048% to -0.241%. This release can be broadly characterised as neutral.

It's worth noting the market’s reaction to this data. The response was muted, with trading sessions closing with a slight decline. The PCE figure of 2.2% came in below the 2.3% forecast in the Fed's Summary of Economic Projections (SEP) for the end of 2024. Moreover, the year-on-year decline of 0.3 percentage points (from 2.5% to 2.2%) becomes clearer when rounding is applied, revealing a drop from 2.454% to 2.236%.

The market's subdued reaction can be attributed to the mixed nature of the PCE report, particularly the rise in core inflation. Additionally, it’s possible that investors are starting to interpret PCE data differently. While the deflator measures price changes rather than consumption volume, a significant drop below consensus expectations could be viewed as a sign of reduced consumer spending, potentially serving as an indicator of recessionary risks.

*According to Carson Research, the S&P 500 has not experienced nine consecutive months of positive returns since World War II. However, there have been eight instances where the index saw growth in eight out of nine months, and in all of those cases, the fourth quarter also recorded gains.

**CME FedWatch - CME Group: https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

Block 3: Indicators

Fear and Greed Index

The Fear and Greed Index showed little change, with a slight increase in the "Greed" territory, edging closer to the "Extreme Greed" level. The only component still in neutral territory remains the volatility index (VIX).

Insider Activity

Insider activity remains at local lows, with a modest uptick in purchases (from 28 to 57) and a reduction in sales. Following a sharp decline in sales since mid-September, the ratio of purchases to sales stands at approximately 0.7x. However, overall activity is still very subdued.

Federal Reserve Balance Sheet

The Fed's balance sheet continues to shrink as per the planned quantitative tightening (QT). During the press conference following the FOMC meeting, Jerome Powell indicated no near-term changes to QT. The balance sheet currently stands slightly above $7 trillion, which is already below the local peak seen in the summer of 2020.

Who's to blame and shat is to be done?

It has been nearly two weeks since the scheduled FOMC meeting and the unexpected 50 basis point rate cut. How has the financial landscape in the U.S. changed since then?

The equity market responded with moderate growth across key indices:

In the manner characteristic of this year, the indices rose largely due to high-cap companies. However, the stark divergence typically seen — such as the growth of the Magnificent 7 alongside the modest rise in the S&P 500 and the decline of the equal-weighted S&P 500 — was not evident, suggesting that the growth was more broadly based. Even the small-cap Russell 2000 ended in positive territory. Small and mid-cap companies, particularly those in the Russell 2000, are expected to benefit from the rate cuts, but the index’s heavy banking sector (9%) may exert downward pressure. It's also worth noting that analyst revisions for companies in this segment have been in negative territory for several years.

***The Net Revisions Index is a composite indicator that measures analysts' sentiment regarding the future performance of companies. It is calculated as the difference between the number of upward (positive) and downward (negative) revisions of forecasts, expressed as a percentage of the total number of forecasts.

In the bond market, the reaction was mixed. Short-term yields declined, while medium and long-term yields edged up slightly, partly influenced by the recent geopolitical tensions following news of missile attacks in Israel. The result is a steeper yield curve, reflecting changing expectations for future rate cuts. Investors are now pricing in a more gradual approach to rate cuts, with the next likely 25 bps reduction expected during the Fed’s November meeting. The spread between 1- and 3-month Treasury yields and the Fed funds rate sits around -0.2% and -0.4%, respectively, suggesting another 50 bps cut by the end of 2024.

The corporate debt market reacted predictably, with credit spreads tightening across most maturities and ratings. Financial conditions had already started to ease before the rate cut, as reflected in the declining yields and rising corporate issuance. Corporate bond issuance is up 32% year-on-year, currently at ~$1.3 trillion, with forecasts suggesting it may hit $1.5 trillion by the end of the year. These new issuances have been readily absorbed by funds and investors alike.

The chart above illustrates the dynamics of credit spreads across all ratings within the investment-grade segment, highlighting a notable reaction: the only rating to see an expansion in its spread is the "BBB-" segment, representing the lower boundary of investment-grade ratings.

When considering overall market "liquidity," two key aspects stand out:

• The volume of assets in money market funds increased by approximately $100 billion, reaching a new historical high of $6.4 trillion after a slight decline.

• The volumes of reverse repos increased from $239 billion to $465 billion, which effectively "withdraws" liquidity from the market.

This trend is likely to strengthen, considering that at the current stage, the yield on repo transactions exceeds the yield on ultra-short-term bills (up to 1 month).

Conclusion

Since the rate cut, there haven’t been drastic changes in either the equity or debt markets. Future price movements will largely depend on how expectations around rate cuts evolve, driven by labor market data. In the bond market, we’re approaching the end of a window to lock in attractive yields for medium to long-term horizons (5-7 years and beyond). As for equities, September's positive close sets the stage for potential further gains toward the end of the year, although a moderate correction in October remains possible. Looking ahead to next year, the outlook is much more uncertain. While monetary policy plays a smaller role, investor risk appetite is now a dominant factor driving market movements.

The chart below illustrates the weighting of growth drivers in recent years, with risk appetite now far outweighing monetary policy as the leading catalyst for stock market performance.

Block 4. EU Update

During the week, broad European indices closed in the green, while the bond segment showed moderate growth. The most significant piece of information related to the Eurozone economy is the inflation data release.

According to Eurostat, inflation in the Eurozone fell below the ECB's target level of 2% for the first time since 2021, coming in at 1.8% (down from 2.2% in August) amid a sharp drop in energy prices. Core inflation also decreased to 2.7%, which supports market expectations for a quicker easing of monetary policy.

Markets are pricing in almost a 90% probability of another rate cut at the ECB meeting on October 17. ECB President Christine Lagarde confirmed that the improvement in the inflation situation will be taken into account in decision-making. Following a 25 basis point cut in October, another reduction is expected in December, bringing the rate down to 3%.

The acceleration of easing has been made possible after an unexpected contraction of the Eurozone economy in September, according to S&P Global, which further reduces inflationary risks. However, inflation in the services sector, which the ECB focuses on, remains high at 4% in September, which could slow the process of further rate cuts.

Block 5. Great Britain

Over the week, broad UK indices closed mixed, while government bonds faced sell-offs. During this period, key macroeconomic statistics include the finalized GDP data for the second quarter, which was revised downward.

In the second quarter of 2024, the UK economy grew by 0.5%, which was below the initial estimate of 0.6%. This indicates that the recovery from the recession has slowed. Expectations for economic growth are decreasing, which is a negative signal for Prime Minister Keir Starmer, who is hoping for accelerated growth to fulfill pre-election promises regarding improvements in public services. Meanwhile, economists anticipate further slowing in the second half of the year, particularly against the backdrop of concerns over potential tax increases and cuts in public spending in the upcoming October budget.

Data indicating weak household spending growth and a slowdown in GDP growth, alongside an increase in savings to 10% (the highest since 2021), confirm that consumers remain cautious despite rising incomes. Business investment growth has been revised upward to 1.4%, while the current account deficit has widened to ￡22.4 billion due to rising imports.

At this stage, investors expect with 100% certainty that the Bank of England will lower rates during the meeting on November 7.

Disclaimer:

This information serves as a snapshot of market trends and does not constitute financial advice. Always conduct thorough research or consult with a financial advisor before making investment decisions.