US bond yields rebounded and the equity rally slowed on Monday. The U.S. 10-year Treasury note has rebounded from last Friday’s low, and the S&P500 is consolidating gains near three-week highs. Opinions vary as to whether last week’s risk rally is on solid enough footing to expand into a Santa rally, or whether it will simply fade. And it all depends on what matters most to investors.
Softening expectations from the Federal Reserve (Fed) and other central banks and falling government bond yields are positive for equity valuations, but talk of potentially higher rates for longer, growing signs of a slowing global economy and rising odds of recession don’t offer a bright outlook for equities as we head into year-end.
Seasonally, November and December are known to be good months for S&P500 stocks. Historically, the S&P500 has gained an average of 1.8% in November and 0.9% in December. But this year, the picture is overshadowed by a lot of weak guidance and earnings warnings.
The talk of weak demand and profit warnings is not good for stocks, but the worst news would be sticky inflation despite slowing growth and a prolonged period of high interest rates. For now, the perception is that the Fed is “done” with rate hikes.
But Powell is due to speak this week and he is likely to leave the door open to a hike… otherwise he knows that all the efforts of the past 1.5 years will be thrown out the window in an instant as everyone rushes to US Treasuries – which would drive down yields and loosen financial conditions, eventually boosting growth and inflation. That’s not what the Fed wants.
And despite a string of no rate hike news from major central banks including the Fed, ECB andBoE over the past few weeks, theReserve Bank of Australia (RBA) hiked rates by 25bp today, as widely expected.
The RBA hike came as a sour reminder that there is no rule that says a bank can’t raise rates after a four meeting pause. Interestingly, the AUDUSD fell after the decision, along with the Australian equity markets. Today’s rate hike did more to revive economic slowdown fears than appetite for higher Aussie yields – while a broad-based recovery in the US dollar and weak Chinese trade data certainly didn’t help.
Speaking of weakness
Chinese exports, a good gauge of global economic health, fell for the 6th month in a row and Iranian oil exports fell for the 2nd month in a row to 1.43mbpd as demand in Asia weakened. That’s certainly why we haven’t seen oil prices react to the news of escalating tensions in the Middle East and the news that Saudi Arabia and Russia will keep their oil production cuts in place over the weekend.
The barrel of crude oil is trading just above the psychological $80 mark this morning. We revise our medium-term outlook for crude oil from neutral to negative. Last week’s sustained sell-off despite a broad-based risk rally, the oil bulls’ unresponsiveness to normally price-supportive geopolitical developments, and the fact that the market’s focus is shifting from the supply to the demand side suggest that a break below $80 is increasingly possible, and that a verbal intervention from Saudi Arabia or OPEC won‘t prevent a deeper decline in the short term.
Iran’s involvement in the Gaza war could be a game changer, but American crude is now in the medium-term bearish consolidation zone and will remain bearish below $81.50, the key 38.2% Fibonacci retracement of this summer’s rally.