Will December continue November’s stellar risk rally?

There is no denying that November will be a tough act to follow for the global risk rally. US bonds recorded their best month in 40 years, the global bond benchmark index had its best monthly performance since 2008. The 10-year Treasury yield has fallen to 4.2% currently, in mid-October, the yield was more than 5%. This has been a massive turnaround for one of the world’s most important asset classes, and it has had large knock-on impact for other asset classes.

The S&P 500 is up nearly 10% in the past month, and the Nasdaq is up 10.68%. The Dax also had a good month, up more than 10%, however elsewhere in Europe, the gains have been less stellar, the FTSE 100 has risen 2.84%, held back by the decline in the oil price, while the Cac 40 in France was up by more than 6%. In the currency space, the dollar index fell by 2.83%.

The market tone has shifted largely because inflation is falling around the world, and this has shifted the dial for central bankers. With clear signs that inflation is falling around the world, and signs of weakness in China, central banks are now expected to start cutting rates in the first half of 2024. We have been here before, with investors and traders ending up disappointed when the Fed fails to cut rates. However, inflation momentum is firmly to the downside, and if we continue to see prices fall, as we expect then it gives the Fed leeway to cut rates. As we move into the new year, the Fed can be more reactive to the growth side of their mandate after focussing on inflation for so long.

The CME Fedwatch tool shows that there is now a 60% chance of the first 25 bp rate cut from the Fed coming in March, this is up from a 21% chance one week ago. Last week’s larger than expected decline in the core PCE has moved interest rate futures, which could be a sign of things to come. As we move into the final weeks of the year, we have switched from an environment where there was a wide range of outcomes for the Fed in 2024, to one where traders are rushing to price in cuts. The missing piece of that puzzle is just how deep will those cuts be? It is worth noting that the financial markets including the Fed Funds Futures market has moved sharply in the just one week, which could suggest that things have moved too far and too fast. Thus, beware any pullback in the bond and stock market rally in the coming weeks. Overall, we continue to think that the prospect of further rate hikes is dead and buried for this monetary policy cycle, which could be bad news for the dollar in the long term.

Economic data watch:

The key event at the start of this week will be Tuesday’s Tokyo CPI out of Japan. The BOJ is the only major central bank that is expected to hike interest rates next year, and this growing interest rate differential with the US and Europe is helping to bolster the yen. The yen index is up nearly 3% in the past month, and USD/JPY is down nearly 2.5%. This pair is now below 147, it could fall further if there are signs of inflationary pressure in the Japanese economy.  The Q3 GDP report from Japan is also worth watching, as economists are expecting a weak figure, with growth expected to have contracted by 0.5% last quarter, and to have fallen by 2.5% on an annualised basis. However, for USD/JPY, all eyes will be on the GDP deflator. In Q2 this was 5.1%, could it rise further? If yes, then it may decide if traders push USD/JPY back to 145.00 in the coming week.

The final PMIs are also released for last month and the US ISM survey for November is also worth watching to see if the goldilocks economic scenario for the US is materialising. ISM services PMI is expected to rise to 52 from 51.8, however, after a stellar Black Friday for many retailers, could this be higher? Later in the week, the market will get a big test with the US payrolls report on Friday. The ADP report on Wednesday is expected to show a gain of 120k private sector payrolls last month, after recording 113k for October. But a surge in holiday workers could put upward pressure on employment for November. The market is also expecting an uptick in NFPs on Friday, with 180k currently expected, up from 150k in Oct. Monthly average pay growth, a fairly useless metric but one the US continues to measure, is expected to rise 0.3% on a monthly basis, but fall back to 4% YoY, down from 4.1% in Oct. The unemployment rate is expected to remain steady at 3.9%. The risk for financial markets is that if we get a large upside shock for the November NFPs, then we could see the risk rally unravel, as big swings in sentiment are happening frequently in 2023.

Oil above $80? Unlikely…

Elsewhere, Brent crude has opened the week slightly higher after Opec+ agreed to make further voluntary production cuts. However, although production cuts could top 2mn b/d, about 2% of global oil supply, the Opec+ secretariat is not announcing who is cutting and by how much, instead that will be left up to the individual members. This suggests that strains are emerging within the cartel, after a year of production cuts. While the market may test Brent crude at $80 per barrel, a toothless Opec + could make it hard to stay above this key level. Thus, any strength in the oil price this week could be seen as a buying opportunity. Of course, there is always the fear that the continued conflict between Israel and Gaza and the US support for Israel, could trigger a backlash from the Saudi-led Opec, but so far geopolitical relations concerning oil have been cordial.