RECAPPING LAST WEEK
Global equity markets remained resilient last week despite another sharp rise in Treasury yields,
with the 10-year yield surging to 5.34%, its highest level since 2002, before pulling back following
Friday’s benign employment report. The rise in yields reflected persistent inflation concerns,
elevated energy costs and increasing expectations that interest rates will remain higher for longer.
The move was not confined to the U.S., with European bond markets also under pressure as the
French 10-year vs. German 10-year spread widened to over 150 basis points. While the U.S.
Dollar continues to benefit from the widening yield differentials, the intra-Europe turmoil driven by
French fiscal issues led to a sharp selloff in the Euro, notably against the zero-interest-rate-
bearing Swiss Franc, which resumed its historical role as a “flight to quality” instrument. Energy
prices provided some relief late in the week after the G-7 countries agreed to release 100 million
barrels of crude oil and diesel from their strategic reserves. This came after reports that the Trump
administration had been pressuring European countries to do so with the threat of the U.S.
implementing a ban on diesel exports. China did in fact implement an export ban on refined
petroleum products, reflecting the continued constraints on refining capacity and delivery being felt
globally. In U.S. equities, mega-cap tech propelled the Nasdaq 100 into all-time highs, led by
market cap leader Nvidia and buoyed by accelerating record earnings out of Micron. Short-term
interest rate markets also didn’t need to await the release of Friday’s employment report to adjust
expectations of Fed policy as the chance of a rate hike at the October meeting was steadily
reduced throughout the week from 64% to only 18%. Helping along the way was the mid-week
release of the Personal Consumption Expenditures index—which we all know is “The Fed’s
Preferred Inflation Gauge.” The annualized rate came in at 3.0%, a tenth below the low-end of
market expectations and 1% away from the Fed’s stated target. The employment report showed
considerably weaker job creation than expected. September payrolls increased only 29k, versus
expectations of 85k, while the unemployment rate up ticked a tenth to 4.2%. The knee-jerk
reaction to the release of the data was a rally in stocks, bonds, precious metals and crypto, and a
decline in the dollar amid lessened expectations of an urgency for the Fed to hike rates. However,
the reaction was short-lived as all the asset classes soon reversed course—with the exception of
the ever-resilient tech-heavy equity indices.
THE WEEK AHEAD
The U.S. fixed income markets will get a test of the market’s appetite for longer-dated issues as
the Treasury conducts their monthly auction for 10-years and 30-years on Wednesday and
Thursday, respectively. The Bank of Japan will also be issuing 10-and 30-year JGBs next week and
investors will surely be keeping an eye on whether the blowout in spreads between French and
German debt has the sort of aftermath of similar instances on European sovereign debt spread
divergences. The minutes from the Fed’s September meeting will also be released on Wednesday
and should provide additional insight into the policymakers’ views on dealing with still elevated
inflation. The mega-cap techs seem least concerned with the rise in yields as the expectations of
returns on their AI investments are overshadowing the elevated funding costs as a mere
inconvenience. But behind the tech-dominated index numbers, there’s certainly a divergence
between the chipmakers who have been the real-time beneficiaries of all the spending and the
hyperscalers who have tapped the credit markets to the tune of $220B this year. It’s the former
who have driven the Nasdaq 100 to new highs while the latter group has lagged. One may think a
little concern for the elevated levels is being expressed in the options market as well as the spread
between implied volatility of 30-day Nasdaq 100 options (VXN) and S&P 500 options (VIX)
reversed course from its steady narrowing since mid-June to widening out this past week. Of
course, one also observes that this spread widened out considerably when the chipmakers had
their historic run during April and May.
(Schwab)
