Thoughts of the Week #9
Weekly Market Recap | Week of November 25, 2024
This Week in Review …
The Week Ahead …
Bond Markets
US bond markets steady after September's sell-off. Since 10Y yields topped 4.5% on Nov. 15, it quickly reversed course. 10Y yields closed at 4.4% last week, slipped further in Asia trading Monday after Trump's secretary pick of Scott Bessent to 4.36%. Scott Bessent is a 'Fiscal Hawk' - a strong supporter of tariffs and shadow chair for the Fed. PIMCO stated believes 10Y remains attractive above 4%. With federal debt negatively correlated to equities, it remains a traditional hedge. Swap traders are pricing in a 66bps of total reduction by Dec 2025. Should Trump sharply cut taxes and boost tariffs, 10Y could hit 5% last seen in Oct 2023. With Fed's preferred inflation gauge, PCE prices on Wednesday, markets will get better insights. [1]
PBOC held 1Y MLF facility at 2%. Economic data shows signs of stabilisation in Oct after the wave of stimulus, keeping on track for 5% growth. PBOC offered CN￥900B via the tool, with a net withdrawal of CN￥550B in November. China is using the 7D reverse repurchase agreements as the key anchor to revamp its policy rate framework. PBOC has also utilised outright reverse repo and purchase of government bonds to boost liquidity. PBOC expected to cut RRR in early 2025 after positive economic data. A RRR cut bundled with a rate cut would send stronger signal for markets. China's 5 largest tech firms have lost $41 billion in market value, with the HSTECH index falling into bear territory. Despite cautious optimism about the unprecedented government stimulus, the selloff has deepened due to concerns over Trump's potential return and underwhelming fiscal stimulus from Beijing. The full extent and timing of China's support remain uncertain, as it is being rolled out in stages, leaving the macroeconomic outlook unclear.
Junk bonds in EM risks being an interlude between the debt crisis of the past 4Y and a new bout of distress in the next four. HY sovereign debt is heading for a 15% surge, the biggest gain since 2016. The rally has shown resilience even with US yields spiking over the last 2M.
Trump's return has raised doubts on the longevity of this rally. The world's poorest nations - which form the bulk of the EM junk-bond universe - stand to lose the most from US trade tariffs, boosted government spending and deporting foreigners without visas. Scott Benson will likely push the Fed to pause cuts keeping higher-for-longer interest rate global environment. Effectively weakening EM against the dollar, amplifying challenges for counties already grappling with economic vulnerabilities. [2] The key challenge to EM lies in the long-term impact on credit flows. Countries with high debt, high gross financing needs, hidden off-balance sheet liabilities and an inefficient public sector and facing geopolitical liabilities are the most vulnerable to capital flight. With the increased Trump policy risk, 585bps of yield premium may not be enough.
Corporate bond shorts have also risen 25% to almost $366B compared with a rise of 10.6% in institutional longs. The rise in shorts come from a gauge of complacency reaches the highest level since 2021. The amount of distressed debt fell to the lowest this year with US economic growth confounding skeptics. Large inflows into HY bond funds in US and Europe are causing spreads to tighten further. Should valuations tighten, shorting bonds can become highly profitable. Any signs of deterioration in the market outlook will also give funds a reason to short securities. Apollo Global Management reiterates that US fiscal policies are on an 'unsustainable path'. S&P 500 earnings misses are on the rise as funding cost in overnight repo markets are rising at a concerning rate. Germany's economy has been moribund, and China has yet to reap the reward of the wave of stimulus. Spreads in US junk bonds stand at 30bps above their all-time lows in the GFC. Risk premiums in Europe still have room to go before reaching their trough. In the coming week, ~$15-20B US high grade bond sales are expected. Europe expects ~$10.4B of sales.
Commodities
Base metals and iron ore gained as the dollar fell the most in 2W following Trump's treasury nominee. All major contracts on the LME advances tracking gains in stocks and other risk assets. Investors expect Bessent to prioritize economic and market stability over more radical measures. This is a reversal from the torrid few weeks following Trump's victory. Traders are also tracking China's efforts to shore up its economy after the wave of stimulus. Copper rose 1.2%, Aluminum added 1.1% and Zinc gained 0.9%.
Gold fell with focus on Fed's interest rate decision. Bullion fell 2% to below $2.7k /oz despite a slide in the dollar. [3] With reports of US business activity expanding at a faster pace than April 2022, swap traders see a <50% chance of a rate cut in December. Higher borrowing cost weighs on the interest-free gold. Prices continue to reflect the interplay between geopolitical risks and a less dovish outlook of the Fed. Any upside inflation could further sway bets towards a potential rate hold, offering resistance to gold. Central bank's November minutes, PCE and consumer confidence are slated for this week. Spot gold fell 1.6%.
Oil edged lower after rising the most in 2M last week. Brent crude slipped below $75/b after jumping over 6% the week prior, WTI at $71. The Russian-Ukraine war has escalated with the use of longer-range missiles by both sides, raising concerns that crude flows could be affected. Iran said it will increase its nuclear fuel-making capacity after being censured by the UN's Internation Atomic Energy Agency, as the OPEC producer braces for potential oil export sanctions under Trump. Oil has traded in a range of ~$6 since mid-October as geopolitical tensions offset expectations of a glut in 2025. OPEC will meet this weekend to decide on production. It is expected to delay a planned increase for a 3rd time. Time spreads are showing increased bullishness, with most spreads moving further into backwardation, where near-term prices are more expensive than those further out. Brent's 3M spread was at $1.21/b in backwardation compared with 70 cents a week ago. [4]
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FX Markets
Currency traders are betting that Trump's policy agenda is about to jumpstart volatility in the $7.5T/day FX market. The 1Y gauge of volatility on the euro-dollar exchange rate surged post-election.
With Trump's America First policies expected to fuel inflation, traders expect widening policy gulf between Fed and its peers. Banks have slashed forecast of the EURUSD anticipating a slide toward parity. Market projections for a stronger USD under Trump also support the case for elevated hedging cost due to the correlation between USD and volatility at its strongest when USD is in high demand. The Republican control of the House and Senate may mean policies get implemented harder and faster. The wild card of day-to-day currency moves in response to the president's tweets as seen in his first term. Deutsche Bank warns that a 'maximalist' scenario where Trump enacts his most extreme policies is only 30% priced into the markets.
Bitcoin
Bitcoin steadied after the rally to $100,000 fizzled. Bitcoin fell to $95,776 before rebounding following after Trump's Treasury pick. Trump is viewed as a crypto tailwind. The overall value of the digital-asset market has surged ~$1T since Nov. 5, backed by promise of friendlier regulations and pledge to set up a national Bitcoin stockpile.
Leveraged ETFs centered on MicroStrategy, a pure-play bet on Bitcoin saw a combined $420M inflow amid a 24% surge in the underlying stock. The popularity has led to a leveraged loop buying frenzy. Investors' demand for the ETFs pushes up the price of MicroStrategy, allowing it to raise more money to further prop up Bitcoin itself. [5] Nomura estimates that leveraged ETFs bought $2.1B US stocks as of last Thursday's close - the highest on record. Trading these kinds of single-named products also surged to record highs.