US Debt Dumped, Other Assets Ignored
The biggest story of last week was the sell-off of U.S. Treasury bonds, with a surge in yields not seen since the Greenspan era, spanning three generations of Federal Reserve chairs. However, other risk assets chose to ignore this, with U.S. stocks continuing to rise, the NASDAQ just shy of its all-time high, commodity prices increasing, gold and silver briefly touching record highs, and funds continuing to flow into investment-grade bonds and stock ETFs. The turmoil in Treasury bonds seems not to have changed the risk-on environment.
The surge in Treasury yields led to a rise in the U.S. dollar exchange rate, with the U.S. dollar index strengthening throughout the week. The yen depreciated to 152 against the dollar, and both the euro and the pound fell. Israel launched attacks on Iranian military targets, driving up oil prices, with gold touching high levels again and silver reaching a new high since 2012. The Bank of Canada cut interest rates by a large margin of 50 basis points, while the Central Bank of Russia raised rates by a substantial 200 basis points in one go.
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The yield on the U.S. 10-year Treasury bond skyrocketed from 3.74% at the beginning of October to 4.20%, and the ICE BofAML MOVE Index, which measures the volatility of U.S. bonds, rose to its highest level in a year. The first reason for the bond market's plunge was that the market consensus became an economic soft landing, and the need for the FOMC to continue cutting rates was questioned. From the pricing in the futures market, funds now believe there is a one-quarter probability that the FOMC will pause one rate cut in the last two meetings of the year, while three months ago, funds believed there was a three-quarters probability of a substantial rate cut in the last two months.
In my view, the current adjustment in the bond market is a correction to the previously overly aggressive expectations of rate cuts.
Over the past two years, the capital market has periodically used recession to scare itself, but this expectation has been constantly debunked by new data and the current state of the economy. The U.S. economy has reached the end of the economic cycle, and logically, the unemployment rate should now be around 5%, with monthly job gains below 50,000 and wages barely growing. However, in reality, the U.S. unemployment rate is only 4.1%, with monthly job gains exceeding 250,000, and wages growing at an annual rate of 4%.
Faced with such numbers, I cannot conclude that the U.S. economy is about to fall into a recession. Interestingly, the number of Wall Street economists predicting a recession is far lower than the number of Wall Street traders predicting a recession, but traders vote with real money, and the Fed cannot afford to ignore this. To some extent, the interest rate swaps in the futures market have hijacked the Fed's policy decisions, and Fed Chairman Powell's substantial rate cut at the September FOMC meeting was directly related to the market pricing at the time.
Both economic growth and consumer willingness are returning to normal patterns, and the battle against inflation has already been largely decided, so it is necessary for monetary authorities to shift the policy environment from restrictive to neutral. This is not easing, but just tending to neither loose nor tight. Maintaining high transparency in policy operations and allowing market mechanisms to find the economic bottom on their own should be the main tone of the Fed's rate cuts this round. I maintain the consistent judgment of this column, with one rate cut in each of the last two months of this year, and a total of 4-5 rate cuts next year, with the timing roughly evenly distributed.
By the way, the upcoming October non-farm employment data may show a significant decline in job gains, and there is even a chance of recording the first negative job growth in four years. The impact of hurricanes is an important factor, with an estimated reduction of 170K jobs, but it's not just weather factors, as various cyclical indicators point to further economic and employment decline. The short-term jobs brought about by the heated presidential campaign will disappear after the election. If the non-farm employment numbers plummet, a 25 basis point rate cut in November will be almost certain.
The Economist magazine has presented several interesting numbers on the global positioning of the U.S. economy. Thirty years ago, the U.S. economy accounted for about 40% of the G7 economies, and now it has exceeded half. The per capita output of the U.S. is 30% higher than that of Western Europe and Canada, and 60% higher than that of Japan. Mississippi is the poorest state in the U.S., but the average income of its residents is higher than that of the UK, Canada, and Germany. These numbers are inflated, with currency expansion and the appreciation of the dollar raising the value measured in U.S. dollars, but they still roughly reflect the widening gap between the U.S. and other major economies.
The market value of seven U.S. technology companies exceeds the total market value of the stock markets of Japan, the UK, Germany, and Canada. The expenditure on research and development by Amazon alone exceeds the total R&D expenditure of the UK and all its enterprises. The capital market leverages and rewards scientific research, scientific breakthroughs drive investment, and the influx of immigrants provide a continuous source of momentum for the U.S. economy. This is the general logic of the development of the U.S. economy over the past thirty years, and its success is evident.However, the American political scene is also rife with chaos. The small government, big market approach that began in the Reagan era has given way to strong government regulation and intervention. The free-market economy that the country was built on has been fragmented by various industrial policies, tax breaks, and trade sanctions. Politicians sacrifice the long-term interests of the nation and the people for their own and their party's short-term gains, and the healthy interaction between political parties has disappeared. Among the populace, there is an increase in extremist ideologies and radical behaviors. Whether the new president can lead the United States out of the political quagmire remains to be seen.
There are three focal points this week: 1) Non-farm employment is expected to show zero growth, compared to the previous period's 254K. In addition, 2) the U.S. third-quarter GDP is forecasted to grow by 3.1%, with consumer spending increasing by 3.2%, compared to the previous period's 3.0% and 2.8%. 3) The U.S. September core PCE is anticipated to increase by 0.3% month-on-month, compared to the previous period's 0.1%, with income growth at 0.3%, compared to the previous period's 0.2%. 4) The Eurozone's third-quarter GDP is expected to show zero growth. 5) The Eurozone HICP inflation forecast is 1.7%, the same as the previous period. 6) The UK Chancellor of the Exchequer, Rachel Reeves, is set to release the Autumn Budget, with significant tax increases anticipated. Finally, China's PMI, the Bank of Japan's regular meeting, and the U.S. ISM also require attention.