U.S. stocks are trading modestly higher on Monday with little macro news to trade on. However, positive risk sentiment from last week remains intact amid a more benign interest rate environment.
10-Year US Treasury yields were little changed on Monday, and as interest rate volatility eases, yields are settling around 4.45% after briefly touching 5% just a month ago. Last week’s drop in CPI inflation helped to push rates lower and provide support for equities – especially longer-dated tech stocks.
The clear impression is that US data is in the driver’s seat, ISM misses a soft-ish jobs report, and last week’s cooler CPI reading has fueled Fed pivot speculation. “Insurance cuts” in 2024 are a foregone conclusion, as the Fed seems to have bought into the idea that a static policy rate against falling inflation would mean passive tightening.
Increasingly, though, traders are inclined to bet on outright Fed easing next year, putting the dollar on track for its biggest monthly decline in a year.
It’s worth noting that good things tend to happen in the global economic environment when the U.S. dollar weakens. The recent trend of a declining dollar is reminiscent of November 2022, when a noticeable drop in the U.S. Consumer Price Index (CPI) report led to lower Treasury yields and a weaker dollar, contributing to improved financial conditions and a boost for equities.
In addition to the ricochet into equities, the dollar’s decline in November is supporting Asian EM FX. The MSCI gauge is at its highest since February, with YTD highs just a few points away.
The weaker dollar is a relief for the region’s central banks, which had previously been scrambling to support their exchange rates. The current backdrop allows them to feel more comfortable, and there is potential for them to more confidently advocate a stronger currency or even cut rates to support the economy.
However, there are several caveats to consider.
Falling inflation in the US and substantial wage gains are positive for workers’ real spending power and could contribute to a soft landing. However, excessive wage growth could complicate the fight against inflation. Ongoing labor disputes and collective bargaining in the US and Europe, resulting in high nominal wage settlements, could keep wage growth robust in real terms, potentially influencing policy decisions.
In addition, there is a possibility that November’s soft data in the US could be a temporary blip, and upcoming data releases in December will provide a clearer outlook. Nevertheless, the prevailing momentum suggests a favorable environment for dollar bears and bond bulls.
Just remember, it’s all fun and games until the US economy actually crashes.
No crystal ball is more accurate than another. It is conceivable that the S&P 500 will reach 4700 by the end of 2024, assuming 2% GDP growth. However, the benchmark could climb to 5000 if growth is robust and inflation continues to fall, or it could plunge to 3700 in a recession scenario.