The Weekly Update

Last week, in spite and because of broadly stronger macro data, central-bank-speak and the new US-Mexico-Canada Agreement (USMCA), both bonds and equities retreated in unison; developed markets also fell alongside emerging markets as risk aversion rose. S&P 500 Index was down a percent while US 10-year Treasury yields rose 5.6bps to 3.23% with the curve steepening: the 5/30-year term spread rose 8bps from 25bps to 33bps.

Stronger than expected September ADP report and a strong September non-manufacturing ISM report in conjunction with Fed Chair Powell’s comment that policy was ‘a long way from neutral’ has put bond markets under pressure. All this has not been helped by a continued heavy Treasury issuance schedule to fund the burgeoning fiscal deficit. US fiscal stimulus at this stage of the cycle has significantly increased the risk of a policy mistake while trade tensions represent a significant risk to the global growth outlook. The unemployment rate edged lower to 3.7%, the lowest level since 1969, but in line with the FOMC projection for 2018 and they forecast it to go lower to 3.5% in 2019. Average hourly earnings were in line with expectations rising 2.8% yoy.

Also, following the latest Fed rate hike, and ongoing inflows more than filling the supply of sub-investment grade debt, US junk bond spreads reached their narrowest since July 2007; hunting for yield and a series of generally solid quarterly earnings across US corporates have also been factors. With this narrow junk premium being a familiar late-cycle signal, watching speculative bond and equity fund outflows, default rates and lending confidence in this sector becomes increasingly significant. Acceleration in any or all of these would give strong reinforcement to justify a flight-to-safety.

This week starts with Japan’s trade balance and current account data on Monday whilst the US is closed for Columbus Day and Shanghai reopens after a week’s holiday, UK GDP and industrial production on Wednesday, US CPI on Thursday and Eurozone industrial production Friday along with third-quarter earnings from a number of big banks.

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