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MARKETSUS stocks traded in a relatively stable manner on Monday afternoon, fluctuating between slight gains and losses within a narrow range. Investors were seemingly taking a breather after the best week of the year for equities, with US bond yields remaining a key factor influencing market sentiment.The slight rebound in US 10-year yields has introduced a minor corrective element to the unbroken confidence that investors had shown following last week’s Federal Open Market Committee (FOMC) meeting.The recent extreme movements in interest rates, both the sharp rise and the subsequent decline, have been disproportionate to the size of the actual economic surprises. Such exaggerated market moves can often be followed by a period of mean reversion, where prices may revert to more recent typical levels,Given the current circumstances where bonds are the primary driver of market dynamics, and stocks are essentially going along with the flow, the central focus remains on the upcoming US refunding bond auction this week, where the significant drop in 10-year yields last week implies that the matter will be challenging to value “WI’s” and even “on -the run” at the moment, as bonds are rich compared to recent levels. Hence, with bonds back in price discovery mode, it creates an environment where stocks at the index level are somewhat directionless, mainly at the beck and call of US bond yields but perhaps skewed to profit-take after last week’s sharp moves higher.Delving deeper into individual stock performance today, you can observe some divergence in the form of product cycle stories. In the Healthcare sector, for instance, the focus is shifting from COVID-19 to obesity and Alzheimer’s products, and this transition is having a notable impact. Shares of LLY (Eli Lilly and Company) are among the top performers today in this context.Interest in the latest edition of the Fed’s senior loan officer opinion survey was undoubtedly greater compared to the levels of anticipation before the Fed’s tightening efforts. However, with two successive anticlimactic releases in April and July, it’s challenging to claim that anyone was eagerly awaiting this report.As of now, market-based indicators of credit risk seem to be unfazed.If you delve deep into the data, you can plot it in various ways. However, the recent survey doesn’t indicate a significant deterioration that aligns with a rapidly worsening credit crunch in the US. When considered alongside the Financial Conditions Index (FCI) easing observed in last week’s “everything rally” and the concurrent weakness in the US dollar, it’s reasonable to say that the Fed might be risking an early improvement in credit conditions, potentially at the expense of the fight against inflation.But to be sure, the recent string of weaker economic data contributing to last week’s Treasury rally implies that the economy is slowing down. It also suggests that the monetary policy transmission channel, even though impaired by the low share of variable rate debt on household balance sheets and the terming out of corporate debt profiles in 2020 and 2021, is not entirely ineffective. With incrementally tighter lending standards, it is reasonable to expect some added pressure on the economy.
OIL MARKETSThe push-pull between propping up prices through OPEC’s production cuts and the impact of the Middle East powder keg premium vaporizing and a slowing global economy was on full display overnight. After an OPEC production cut extension triggered some speculators to buy the dip, driving a modest 1 % rally in oil, higher prices gave way to the economic reality and no broader Middle East conflagration.Oil prices steadied at the start of the week due to rising tensions in the Middle East and the confirmation of production cuts by Saudi Arabia and Russia for the next month. The Saudi energy ministry hinted that unilateral cuts could extend into 2024, ostensibly reflecting concerns about weaker demand.Crude prices had fallen 6% the previous week, and the geopolitical risk premium that briefly appeared in October has since evaporated.Maintaining a floor under oil prices is crucial for the Saudis, as it helps fund their recent sporting and luxury expenditures.From a macroeconomic perspective, the Saudis face enormous risks. By artificially keeping oil prices high as demand weakens, they may prolong this challenging situation. If the Chinese economy is experiencing difficulties and consumers in developed countries are cutting back, elevated oil prices could exacerbate the issue by reducing demand.On the geopolitical front, there is currently no supply disruption story. However, a state-on-state conflict with Iran would be required to change that, and Tehran seems to have no appetite for it. They are currently content with projecting their influence through proxies such as Hezbollah, groups in Iraq, and the Houthis. A conflict with the Israeli Defense Forces would essentially mean a war with the United States, which would ultimately result in the end of the regime. Khamenei is aware of this fact.Notably, the risk premium associated with war has also come down in options markets, suggesting reduced concerns about immediate conflict.The presence of two ongoing conflicts, such as those in Ukraine and the Israel-Hamas situation, keeps the door open for the reintroduction of geopolitical risk premium in the future. Geopolitical events and crises can flare up unexpectedly, leading to sudden shifts in market sentiment and risk assessments. Therefore, the potential for renewed geopolitical risk remains a concern for financial markets.
FOREX MARKETSWith the BoJ’s gradual approach to policy is relatively minor and won’t significantly strengthen the yen. With the US economic outlook still appearing on solid ground and the potential for high US yields to remain higher for a while longer, the yen is not expected to strengthen too much over the short term. While there may be some bumps along the road, like the risk of intervention and possible yield relief driven by softer US data, significant yen strength is unlikely without a substantial hiking cycle from the BoJ, cuts from the Fed, or a US recession.More By This Author:The US Bond Auction Is The Central Focal Point Of Attention This Week
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