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MARKETS
Following an initial surge early in the session, U.S. stocks maintained a strong performance, with the S&P 500 steadily grinding toward record territory. Notably, the Dow achieved another record high, contributing to the overall impressive showing on the broader New York ticker tape.
Without a tablespoon of doubt, investors are encouragingly acknowledging that inflation has experienced a notable decline across most major economies from the peak observed last year. Notably, this has occurred without the need for a recession. The United States and most G10 economies outperformed expectations in 2023, and despite this positive economic performance, inflation followed a favourable downward trajectory, confounding many Fed critics.
The welcome retreat in headline inflation, with Personal Consumption Expenditures (PCE) assuredly in tow, is now laying the groundwork for potential interest rate relief in 2024—a point underscored by last week’s decision by the Federal Open Market Committee (FOMC). Consequently, financial markets are currently basking in anticipation of a more festive holiday season, revelling in the optimism of profitable Santa Rally cheer.
Indeed, The Federal Reserve seems ready to offer relief in the coming year, signalling the likelihood of at least three rate reductions in 2024.
And the bond markets are promptly off the races, anticipating the Fed will mechanically take this action as inflation ebbs further. Rates on 10-year Treasury bonds have already dropped to 3.9%, a notable decrease from the 5 % observed less than two months ago, all transpiring without explicit economic softening. Indeed, investors are coalescing around the notion that the Federal Reserve will start trimming interest rates as inflation approaches containment.
The effective single mandate in force since early 2022 appears no longer applicable. Taking the latest Fed guidance at face value, they have seemingly reverted to the dual mandate, prioritizing a foundational level of economic growth, even if it means immolating the proverbial “last” inflation “mile” – such as the transition from 3% core price growth back to 2%.
FOREX MARKETS
The short-covering rally in USDJPY following the BoJ was more robust than anticipated; in my view, it provided an excellent chance to re-enter USDJPY shorts. However, the current time of the year and the unpredictability of year-end financing charges have likely tempered a more substantial reversion. So, we have covered our high 144 reversion trade as liquidity metrics have fallen off in the New York afternoon.
We think the market read too much in BoJ Governor Ueda’s pushback against any notion that Fed policy shifts influence the timing of monetary policy actions in Japan.
The Federal Reserve no longer sets interest rates; the bond market does. After all, from the October highs near 8%, the 30-year fixed mortgage rate has experienced a significant drop, thanks to a remarkable rally at the long end of the U.S. Treasury curve. Freddie Mac’s weekly update showed the six percent handle this week for the first time since August 10.
Notably, the continued rally in the U.S. Treasury market is expected to keep the 10-year JGB yield below the current reference rate of 1%, justifying and providing an open window for a shift in the yield curve control policy in January.
After experiencing a setback overnight, the yen is expected to return to being primarily influenced by U.S. interest rates, where a soft PCE reading could send USDJPY back into the 142 handle. Additionally, market attention will remain focused on statements and communications from Federal Reserve officials.
OIL MARKETS
In response to the disruptions in shipping at the Red Sea and despite Operation “Prosperity Guardian,” a coalition to address security challenges in the Red Sea, oil prices were pushed higher on a combination of holiday hedges and goldilocks arriving at the oil patch.
As the holiday season draws near, achieving a stable outcome for the region appears elusive. The prolonged conflict in Gaza continues to fuel an escalating humanitarian crisis, adding political pressure on multiple actors. This situation raises concerns about a potential expansion of the conflict.
Amidst ongoing rocket attacks and bombings, the inherent uncertainty of war increases the likelihood of unforeseen events and substantial miscalculations, which could lead to further escalation of the already volatile situation.
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