A Global Pause On Rate Hikes

Week Ending 3 November, 2023

There have been three, key developments:

Global Central Banks (CBs) have decided to take a pause over further rate hikes: This follows some two years of rate hikes. The list is long – the US, NZ, UK, Canada, EZ, Norway, Sweden, Australia, Switzerland and Japan (see more below). Nearly all the rhetoric stresses caution to the upside e.g., the Norwegian CB made it clear it sees another rate hike in December, possibly marking the last.
We had the much-awaited October US Nonfarm Payroll data: Markets saw it as a soft print and breathed a sigh of relief. The forecast was for a gain of +170,000. Instead, the print came in at +150,000. A word of caution here – the latest UAW (United Auto Workers) strikes resulted in lost manufacturing jobs of -35,000. Adjust for this and actually the result would have exceeded the forecast. On the flip side, there were downward revisions to the August and September prints totalling some -101,000. Full time jobs grew +326,000 while part time jobs tumbled -670,000. The latter is a curveball seeing as Christmas is soon upon us – interestingly, that might pick up.
Japan’s CB (the BoJ) decided to softly loosen its stance on Yield Curve Control (YCC): Previously, it said it would cap the 10y JGB yield at 1%. This time, it’s allowing room for it to loosely move higher. It said “It is appropriate for the Bank to increase flexibility in the conduct of yield-curve control so that long-term rates will be formed smoothly in financial markets in response to future developments”. It re-defined the 1% on the 10y JGB as a loose “upper bound” rather than a rigid cap removed a pledge to defend the level with any offers of unlimited purchases of bonds. How far might yields go? Well, Japan’s inflation rate is running at 3% (long-term average is 2.42%). With the yield currently at 0.92%, that still a large gap! At present, domestic investors still see opportunity for better yield by investing overseas. At some point though, that has to start turning. When it does, that will be Yen-supportive (currently around 150 to the US$). At the moment, Japan is caught in a loop – Yen falls and this fuels inflation. It needs the opposite the BoJ is orchestrating that by slowly loosening its grip on YCC. Its stock market has been on a tear this year – despite Yen headwinds. Now imagine FX gains on top.

Markets welcomed the above news as equities rallied (enjoying their best week in 2023) while bond yields fell heavily (i.e. bond prices rose). How long could this rally last, if at all? At least until the next inflation releases - in the US, that will be 14th November (for October), for the UK on 15th November and Euro-Area on the 30th. China’s will be roughly mid-November. Everything is pointing to further declines – barring the unforeseen. Even real estate (REITs) had a big kick up on as prices received a boost with the rate pause news. It highlights the dangers of getting caught up in the headlines and moving outright to cash. Bond yield moves are big (US 1y -0.09%, US 2y -0.14%, US 10y -0.11%, US 30y -0.08%) and these translate into big capital appreciation for bond portfolios. You could have locked in short duration yields of circa 5% and supplemented that with capital gains. That would far outstrip returns on Fixed deposit (5% to 6% at best) and run the danger of losing interest accrued for breaking the deposit before maturity.

Lastly, Israel/Gaza? Phase II (a ground war) is imminent. Most pundits are saying it will be a costly, human exercise and drawn-out. How does each side define victory? For the Israelis, it is paralysing the likes of Hamas for several years. For Hamas & Co, it is taking as many Israeli lives as possible and “enticing” other states to get involved. Forecasts of oil prices, should things start to get out of hand, range from $150 per barrel to $250 per barrel. In summary, here is a scenario analysis courtesy of GS, of what could happen to energy prices. I hope they are wrong!