by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Equity markets are treading cautiously ahead of Fed Chair Jerome Powell’s speech, while Real Madrid advances to the Champions League knockout stages for the 27^th consecutive year. Today’s Comment begins with why investors should remain cautiously optimistic about the shift in central bank sentiment. We then give our thoughts on the potential impact of proposed bank regulation changes, and how the Republican debate may hint at future foreign policy direction. As always, our report includes a summary of the latest domestic and international data releases.

Policy Sentiment Shift: Bond investors are convinced that rates have already peaked. However, policymakers seem less certain.

• After reaching their October highs, global bond yields have embarked on a downward trajectory. The 10-year Treasury yield has plummeted nearly 50 basis points since its peak two weeks ago, mirroring the retreat observed in its British and German counterparts, which have shed 40 and 30 basis points, respectively, during the same period. This surge in bond demand has extended to mortgage rates, with the average 30-year fixed-rate mortgage experiencing a 25 basis point decline in a week, settling at 7.61%. The collective pause adopted by central banks has fueled investor speculation about a potential bond rally, leading to a renewed interest in fixed-income securities.
• While investors appear to believe that central banks have concluded their rate-hike cycle, central bankers themselves remain more cautious. Bank of England Governor Andrew Bailey has decisively dismissed speculation of a policy easing in mid-2024, underscoring the ongoing struggle against inflation. Echoing this sentiment, Bank of Canada Governor Tiff Macklem has warned that the lingering effects of energy price shocks could hinder inflation control efforts. Reinforcing this cautious outlook, Federal Reserve Governor Michelle Bowman and Minneapolis Fed President Neel Kashkari have hinted at the possibility of further interest rate increases to ensure inflation’s return to the 2% target.

• The future course of monetary policy will largely hinge on expectations for economic growth. While concerns about a potential recession in 2024 are mounting, similar worries were prevalent at the beginning of this year. One encouraging aspect is the continued resilience of the labor market across the developed world. Even Canada, which experienced a technical recession in the third quarter, boasts an unemployment rate of 5.7%, below its historical average of 7.6%. Most evidence suggests that even if there is a downturn, it is likely to be mild. Hence, a recession may not be enough to pivot policy, especially if inflation returns.

Regional Banks: Several months after endangering the financial system, small to midsize lenders may begin another chapter.

• Regulators want to limit bank access to funds from Federal Home Loan Banks (FHLB). The decision comes after lenders relied heavily on the $1.3 trillion system meant to encourage mortgage loans to meet their short-term funding needs after the fall of Silicon Valley Bank. Several months after the March banking turmoil, FHLB had over $880 billion in outstanding loans to U.S. banks and credit unions. The Federal Housing Finance Agency (FHFA) has proposed requiring banks to hold 10% of their assets in mortgage loans, establishing new safeguards for lending to struggling banks, and implementing stricter stress tests.
• The new rules are designed to help FHLB return to their original mission of supporting banks in providing loans to potential homebuyers, but banks argue that the regulators are overreaching. The banking industry has rejected claims that its problems were due to a lack of regulation and instead are blaming the Federal Reserve’s lack of guidance. JPMorgan CEO Jamie Dimon has ridiculed policymakers for being “dead wrong” on inflation and pleaded for the Fed to show greater humility, given its proposal for more capital requirements. The pushback suggests that regulators may not be able to implement all the changes they want to protect the banking system.

(Source: Federal Reserve)

• New capital restrictions would complicate banks’ efforts to lend across the country. The latest Senior Loan Officer Opinion Survey (SLOOS) shows that banks are already tightening their lending standards, particularly for non-government-backed and non-residential loans. If these rules are implemented, they could dampen the potential stimulative impact of a pivot in Fed policy, which is likely to be less aggressive than in previous easing cycles. This may mean that when the Fed does decide to make the policy change, it might be less successful in generating demand than in previous easing cycles, especially if the rate cuts are modest as we would expect.

Rethinking Defense: Although all Republican presidential candidates have voiced support for Israel in its fight against Hamas, they have taken a more Jeffersonian stance on other foreign policy issues.

• During the debate, most candidates expressed skepticism about further funding for Ukraine. Former UN Ambassador Nikki Haley said the U.S. should support Ukraine by sending weapons, not aid. Entrepreneur Vivek Ramaswamy argued that Ukraine’s occupied areas should remain with Moscow. Republican Gov. Ron DeSantis of Florida and Sen. Tim Scott of South Carolina both expressed concerns about how the money is being spent. In contrast, former New Jersey Gov. Chris Christie was the only candidate to show restraint, warning that the cost was warranted to prevent another world war.
• Their wariness regarding Ukraine comes as Americans are voicing more concern about deteriorating law and order in the United States. A recent Gallup poll showed that Americans’ perception of safety has fallen to its lowest level in five years. The most frequently proposed solution to the rising crime problem discussed on the debate stage was to increase security along the U.S.-Mexico border. Candidates also proposed finishing the border wall and possibly designating drug cartels as foreign terrorist organizations. China was also mentioned, with Haley vowing to stop all trade with the world’s second-largest economy until it prevents fentanyl from entering the U.S.

• The candidates’ notable tone on the debate stage suggests that a sizeable Republican base may now prefer a more Jeffersonian approach to foreign policy, with a focus on domestic issues over global affairs. While the United States may not completely abandon its leadership role in the world, it may need to redefine that role to be more palatable to a populace that has grown tired of its hegemonic status. This could involve off-budget spending programs similar to the Lend-Lease Act or aid packages with strings attached akin to the Marshall Plan.

Other News: Bank of Japan Governor Kazuo Ueda has stated that the central bank will proceed cautiously as it moves away from its ultra-accommodative policy. His remarks suggest that Japanese policymakers may be averse to significant changes in policy. Hollywood actors and studios have reached a tentative agreement to end the 118-day strike, with new restrictions on the use of artificial intelligence technology. The agreement reflects labor concerns about the threat that AI poses. Spanish Prime Minister Pedro Sánchez and the Catalan separatist Junts have reached an agreement that could pave the way for a new government.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning.  Equity markets are mostly treading water this morning, and Chair Powell will speak later today.  Interest rates are also mostly steady, but commodities are mixed as oil and gold are lower while grains are higher.

In today’s Comment, we start our coverage with a recap of yesterday’s state and local elections.  Next is our update on the situation in Gaza.  A roundup of economic and financial news follows.  China is next on the docket, and we close with our international overview.

Elections:  Democrats generally did well last night.  Meanwhile, budgets and AI are background issues.

• Going into last night’s elections, there was a general level of concern among Democrats due to recent adverse polling. However, for the most part, the party outperformed expectations.
  • Abortion continues to bring out voters for Democrats. Ohio voters chose to put abortion access into the state’s constitution, for example.
  • Governor Beshear was re-elected in Kentucky, a deeply red state.
  • In Pennsylvania, voters supported Democrats in local elections despite weak poll numbers in that state for President Biden.
  • In Virginia, Democrats gained control of the statehouse, thwarting Governor Youngkin’s goal of a Republican takeover. This loss may dim his national aspirations.
• The House GOP can’t seem to agree on a plan of action to deal with the fiscal budget. One idea being floated is a series of continuing resolutions, essentially creating a series of “fiscal cliffs.”  To some extent, the budget talks have an air of “rearranging the deck chairs on the Titanic” in that the deficit is spiraling in an unsustainable path, and there is little evidence either party is paying attention.
• We are about a year away from presidential elections, and there are reports that AI generated videos are becoming indistinguishable from real ones, which means that video disinformation may become just about impossible to control. Not only does this create conditions where political operatives can generate mayhem, but it also gives foreign actors outsized influence.  We have been monitoring this issue for some time, and the speed of development has been surprising.  It is unclear how this will affect elections next year, but this factor adds to an already unsettling political environment.

Gaza:  IDF has entered Gaza city, and the U.S. is warning Israel against taking control of Gaza.

• According to reports, Israeli forces have entered Gaza City. This battle will be difficult for the Israelis, since in general terms, defense is easier than offense.  Complicating matters further is that urban warfare is difficult, and Hamas is well prepared for this attack with a well-established tunnel system.  We would expect the conflict to become bogged down from this point forward.
• The U.S. is warning Israel that it probably isn’t a good idea to occupy Gaza. Given how rapidly this situation is evolving (it was a month ago that Hamas attacked Israel), it appears that the Netanyahu government hasn’t sorted out what its plans are.  We note that SoS Blinken downplayed the notion of occupation.  The fact of the matter is that there are no good solutions to this situation which is why the government is struggling with a plan.
• Arab states are increasing their calls for a ceasefire. China and Russia are echoing these calls in a bid to improve their status in the region.
• The EU is facing an increase in terrorist violence, likely in response to the conflict in Gaza. Extremist activity in the U.K., Belgium, Germany, and France has been reported.  The violence appears to be having an impact on immigration policy (see below in International Roundup).
• One of the factors that may have triggered Hamas’s attack was normalization between Israel and Saudi Arabia. The Abraham Accords, for the most part, ignored the Palestinian situation and the fact that Arab states signed on suggests that the Palestinians were not a key factor in relations.  Initially, Riyadh backed away from normalization talks.  However, there are reports the Saudis are still interested in making a deal.  If talks go forward, it suggests that the Palestinians have very little leverage in the region.

Economic and Financial News:  The NY FRB’s household debt data was released yesterday, showing an uptick in borrowing.  Commodities are mixed: oil is lower, while beef and grain prices are rising.

• The NY FRB household debt data showed a modest rise in Q3. The debt balance per capita is just above $60k.

• Company reports are hinting that consumer spending may be slowing down. If so, economic activity will likely also decline.
• Oil prices have declined to the levels last seen before the Gaza event. Although there are worries that the conflict will spread, every day that passes with the war staying in Gaza, the fears clearly dissipate.
• Last summer was dry and hot in the central U.S. These conditions create a problem for ranchers, as it forces them to buy hay to feed their animals instead of using grass, and the hay costs rise due to drought.  The bottom line is that beef costs are slated to rise further.  The CPI for beef was up 7% in September.
• China is increasing its purchases of U.S. soybeans; this buying is boosting soybean prices.

China Update:  The IMF upgrades its forecasts for China’s economic growth while raising concerns over its real estate situation.  Beijing is putting additional controls on the exporting of rare earths.

• The IMF raised its forecasts for this year’s growth to 5.4% from 5.0% and lifted next year’s forecast GDP to 4.6% from 4.2%. At the same time, the IMF warned that China’s housing sector remains a risk to the economy. China has boosted infrastructure spending to lift growth.  We view this action as problematic, but the spending is likely better than allowing for a downturn.
• China announced new measures to control exports of rare earths, along with other major commodities such as oil and iron ore. China has been aggressively building oil stockpiles in recent months.  Some of this rebuilding is taking advantage of sanctions on Russia and Iran, which have depressed prices for their crude oil.  Adding controls is consistent with China’s functioning in a multipolar world.
• China is building its stockpile of semiconductor equipment prior to U.S./EU restrictions.
• Polling in China suggests some softening in hostility towards the U.S. This change may reflect the impact of recent meetings.

International Roundup:  NATO and the U.S. are suspending a 1990 treaty that limited conventional forces in Europe.  Portugal’s PM is out, and we include a note on immigration.

• The U.S. and NATO have formally suspended their participation in a treaty that limited conventional forces in Europe, effective December 7. This action follows Russia’s withdrawal from the treaty.  The treaty was a landmark at the time, signaling a formal end to the Cold War.  The pact limited troop levels and armor that could be held by NATO and the Warsaw Pact states.  It also forced both parties to inform the other where troops were deployed.  However, Russia suspended the treaty in 2007, and it’s unclear why NATO and the U.S. waited so long to retaliate.  The slow response is an indication of policymakers’ denial of Russia’s intentions.
• PM Costa of Portugal resigned yesterday after police raided his residence as part of a corruption investigation. The president of Portugal will either need to appoint a new PM or call for elections.  The probe concerns how EU funds were spent on green investments.
• Immigration has been a “hot button” issue in the EU for some time.  Much of the immigration is coming from Northern Africa and the Middle East.  These immigrants, mostly Muslim, have struggled with integrating into Europe and the social disruption has caused political upheaval in the EU, elevating right-wing parties.  Part of the problem is that Europe is facing a demographic deficit and needs immigrants, but worries about cultural disruptions remain unsolved.  As tensions have risen, individual nations in Europe are taking action, making a EU-wide policy difficult to implement.  The fear is that individual states will try to force the costs of immigration onto other nations, creating fissures within the EU.  At this point, we don’t see how Brussels can contain this trend, meaning that the immigration issue will likely worsen.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning.  It’s a risk-off day in the markets.  As we noted above, global equities are mostly lower.  Commodities are weaker as well on fears of weaker economic growth.  We are seeing a rally in Treasuries in light of broader market weakness.  It’s election day in the U.S.  Although today’s elections are local, political analysts will be looking hard at the results for any insights into next year’s presidential race.

In today’s Comment, we start our coverage with an update on the situation in Gaza.  China is up next, economic and finance news follows, and we close with our international overview.

Gaza:  Netanyahu claims Israel will take “indefinite” control over the Gaza Strip, and the death toll is mounting.

• The Israeli PM indicated overnight that Israel would take control over Gaza to prevent Hamas from retaking power. For Israel, this is a “back to the future” moment, as Israel held control over the area until 2005, when PM Sharon concluded it would make more sense to leave Gaza to the Palestinians and create a hard border around the area.  Returning to Gaza means re-occupation, which is difficult.  However, it is now clear that a Hamas-controlled Gaza is a major threat to Israeli security, thus leaving Netanyahu with little choice.
• According to the health ministry in Gaza, 10k Palestinians have died in Gaza and 25k have been injured.
• U.S. continues to press Israel for a pause. So far, the Israeli government has refused any significant ceasefires without the release of hostages, although it has allowed for some relief supplies to enter the area from Egypt.
• The Israeli military has surrounded Gaza City, essentially cutting the area into two parts.

China Update:  Australia is improving relations with Beijing, the U.S. and China are setting up meetings, as are EU officials, and China’s exports remain weak.

• Relations between Australia and China deteriorated during the pandemic when Canberra called for an international inquiry into the origins of COVID-19. This week, Australian PM Albanese concluded trade meetings with Beijing which apparently have eased Chinese restrictions on Australian products.  General Secretary Xi spoke glowingly of the improving relations between the two nations, suggesting ties are now on the “right path.”  What Albanese is trying to do is what many nations in the region are also attempting, which is to have economic ties to China while also building security relations to contain Beijing.  We note the Australian PM remains cautious about China.
  • Interestingly enough, as trade relations between Australia and China improve, Australia’s talks with the EU have “collapsed.” It may be difficult to maintain security relations when economic activity is stunted.
• Australia isn’t alone in trying to improve relations with Beijing. The Biden administration has been actively arranging talks all year.  There are expectations that Xi and Biden will meet in San Francisco at the APEC summit later this month.  Meanwhile, Treasury Secretary Yellen and Vice-Premier He are scheduled to meet November 9 and 10.
  • Invitations were sent to U.S. business leaders to meet with Xi and Biden during the APEC summit.
  • There are reports the U.S. and China will discuss nuclear weapons in the near future. China has been rapidly expanding its nuclear weapons arsenal recently.
• The EU is also planning talks with China in December. EC President von der Leyen is planning on traveling to Beijing for meetings, although the initial tone appears rather hawkish.
• China is increasingly harassing Western surveillance flights that are looking to see if nations are breaking sanctions on North Korea.
• On the economic and finance front, there were several interesting developments:
  • Gallup is leaving China because the government views its surveys as a “tool” to discredit the regime.
  • The CPC has banned party members from owning private equity. Concerns about corruption led to the decision.
  • Chinese tech mogul Chen Shaojie has been arrested. It is unclear with what he has been charged.
  • China’s exports fell again in October.
  • Slumping pork prices could lead to a negative print on China’s CPI.
  • China’s #2 property developer, Vanke (000002, CNY, 11.93), appears to be in trouble, prompting local governments to step up their support. There is evidence that Beijing is responding to the property crisis by moving to support other industries and through the expansion of central government spending.
  • China has created a network of ports as part of its maritime Belt and Road Initiative. This network could become a major military asset.  The Belt and Road projects have become notorious for pushing nations into debt; China has become a major source of aid that may be designed to support its collection efforts as well.

Economic Roundup:  The Senior Loan Officers Survey was released yesterday; we offer details.

• The Senior Loan Officer Survey was released yesterday afternoon. For the most part, credit standards remain tight but have loosened somewhat.

Demand also showed signs of improvement.

The willingness to make consumer loans was mostly steady.

However, demand from consumers remains soft.

Overall, the survey suggests financing conditions are not getting much worse, but overall, lending standards remain tight.

• Higher interest rates and dollar strength are taking their toll on emerging markets.
• As commercial banks face increasing capital restrictions, they are developing novel ways to distribute lending risks. Banks are increasingly using synthetic risk transfer products, which allow banks to reduce their capital charges on loans.  In return, buyers of these instruments receive high returns.
• In general, funding for any asset can come from either debt or equity. The attractiveness of either method depends on the cost of the funding.  As mortgage rates hit 8%, homebuyers are being offered instruments which are essentially equity participation in the home-buying process.  The firms providing the equity are then creating bonds to sell to investors.

International Roundup:  Germany is struggling to deal with the Alternative for Germany party (AfD), and the incumbent in El Salvador can run again.

• A close advisor to the head of Ukraine’s armed forces was killed yesterday by a bomb hidden in a birthday gift. Major Gennadiy Chastyakov, an aide to General Zaluzhny, died when the package exploded.
• In democracies, there are situations where, if power is closely balanced, individuals can have an outsized impact on policy. In the U.S., such situations are uncommon because a two-party system tends to overwhelm its dissidents.[1]  Multiparty systems, such as those seen in continental Europe, are much more prone to minority parties having significant power.  Major parties rarely win a majority outright, and thus, must court minor parties to form governments.  This means that if the lesser parties become unhappy, they can bring down governments.  We are seeing something like this in Germany.  The AfD has seen its power rise in recent local elections.  The major parties are trying to avoid a situation where they need the AfD to form a government.  What’s driving the AfD’s success is  German’s anger over immigration and energy policy.  Sometimes, minor parties in government can force the larger parties into policies that are unpopular.  If that occurs, as we are seeing in Germany now, it can lead to political tensions.
• In El Salvador, an election tribunal decided to allow Nayib Bukele to run for a third term, in contradiction of the nation’s constitution. Bukele is very popular but was being prevented from running again due to legal restrictions.  Now that those are out of the way, he will likely win; elections will be held in February 2024.

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[1] Although uncommon, it isn’t unprecedented.  The power of Sen. Manchin and Sen. Sinema was in evidence from 2020-22.  And, the power of the Freedom Caucus has had an impact on the House of Representatives.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with an update on the Israel-Hamas conflict, where we continue to see a risk that the fighting could expand regionally and potentially even draw in the U.S.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a new ban on short selling in South Korea and additional signs of softer labor demand in the U.S.

Israel-Hamas Conflict:  The Israel Defense Forces continue to attack Hamas forces in the Gaza Strip, with a focus on stand-off attacks against the entry and exit points of the extensive tunnel network the terrorist government has built throughout the enclave.  The strikes have reportedly trapped many Hamas fighters in the tunnels with no electricity, light, or air conditioning.  Meanwhile, Iranian-backed groups in the region continue to launch drone, missile, and air attacks against Israel and U.S. forces in the region (see map below).  In an effort to reassure allies that the U.S. will carefully calibrate its response to those attacks, Secretary of State Blinken made a surprise trip to several regional capitols over the weekend.

• The IDF reportedly plans to continue its strikes on the tunnel network until at least 65% of its entry and exit points have been destroyed. Outside analysts currently estimate about 50% have been destroyed.
• The continuing rise in reported civilian casualties suggests that Hamas has built many of those entry and exit points under residential and commercial buildings. The IDF insists that it gives fair warning for civilians to evacuate before each strike, but many civilians with no place to go still die in the airstrikes or artillery and tank fire.
• The mounting civilian casualties and growing anger at Israel around the world will probably raise the risk of retaliation, against both Israel and the U.S., by Iranian-backed Islamist groups such as Hezbollah in southern Lebanon. If they continue, they could potentially even prompt attacks on Israel by regional states, including Iran.  In other words, there is still a risk that the conflict will expand into a dangerous regional war that could crimp global oil supplies and drive-up energy prices.

Israel:  As we have warned, the fight against Hamas is now starting to have palpable negative effects for Israeli businesses, with firms struggling to deal with plummeting demand, the loss of workers called up for reserve duty, and consumers in border areas fearful to go out on shopping trips.  Prime Minister Netanyahu has promised vast, pandemic-style cash transfers to affected firms and workers, but the aid package is already being criticized as too small.

Japan:  Now that the Bank of Japan has softened its yield curve control policy and signaled it will let longer-term yields rise, several major Japanese banks have raised the (still miniscule) interest rates they offer on time deposits.  For example, Sumitomo Mitsui Trust Bank, a unit of Sumitomo Group (SSUMY, $21.11) said it will hike the annual interest paid on five-year noncancelable deposits to 0.10% from 0.01% previously.  (So far, we have seen no reports of Japanese depositors dancing for joy in the streets.)

South Korea:  The Financial Services Commission today issued a blanket ban on short selling listed stocks until June 2024.  In a statement, the Commission claimed the ban was necessary to ensure “fair price formation in the domestic market” following “repeated illegal naked short selling by global institutional investors.”  Nevertheless, the move is being seen as a sop to retail investors ahead of next year’s parliamentary elections.  In response, Korean stock-price indexes today have surged as much as 6%.

China-Russia:  On Friday, the Commercial Aircraft Corp. of China, otherwise known as Comac, gave an update on the development progress of its long-delayed widebody jet, the C929, without mentioning its Russian joint-venture partner, United Aircraft Corp. (UAC).  That marks the second time in two months that Comac has given an update without mentioning the Russian firm, which suggests UAC has dropped out of the project.

• If the Russian firm has indeed dropped out of the C929 project, it could signal that the firm is a casualty of the Western sanctions on Russia for its invasion of Ukraine.
• After similarly long delays, Comac’s single-aisle C919 aircraft, designed to compete with the 737 from Boeing (BA, $195.05), began flying commercially only in May.
• Despite China’s successful industrial policies to develop products such as electric vehicles and mid-range semiconductors, it continues to struggle with large civilian airliners. For now, that suggests the global market for such aircraft will remain a duopoly between Boeing and Europe’s Airbus (EADSY, $34.59).

China:  New analysis of Chinese data suggests foreign companies pulled more than $160 billion of earnings out of the country over the six successive quarters ended in September.  Reflecting that, net foreign direct investment in China in the third quarter of 2023 turned negative for the first time in a quarter-century, and the value of the yuan (CNY) fell to its lowest level in a decade.

• The withdrawal of foreigners’ earnings reflects a range of factors, such as rising interest rates in the West, slowing growth as the Chinese economy matures, and headwinds from poor consumer demand, high debt levels, bad demographics, and disincentives arising from the government’s increasingly intrusive control over business.
• In addition, the economy is slowing from foreign decoupling, i.e., new barriers to trade, capital, and technology flows with China. In other words, the pull-out of earnings is also another example of how the world is fracturing into relatively separate geopolitical and economic blocs, as we’ve written about in depth.

European Union:  In an interview with the Financial Times, EU Transportation Commissioner Adina Vălean said Brussels has launched an investigation into the big fare increases of 30% or more that European airlines imposed during the summer.  The European Commission has no authority to regulate airfares, but the probe is a useful reminder that governments around the world may not rely solely on tight monetary policy to fight inflation.  Executive and legislative branches of government can also put regulatory pressure on firms, perhaps including price caps.

Germany:  Tesla (TSLA, $219.96) last week reportedly announced big pay increases for the workers at its “Gigafactory” near Berlin.  Chief executive Elon Musk also promised the workers that they will build the firm’s next-generation electric vehicle.  The moves come as Tesla is trying to fend off an organization effort at the plant by Germany’s powerful IG Metall union.  If the plant is successfully unionized, it would likely encourage efforts to organize other Tesla facilities around the world.

Sweden:  Separate from the German situation, the IF Metall trade union that launched a strike against Tesla in late October claims the company will open talks with it today.  Although Tesla doesn’t manufacture autos in heavily unionized Sweden, it does employ about 120 mechanics at its service centers there, and those workers have been agitating for a union.  If the company ultimately acquiesces to the mechanics’ demands, it could also potentially encourage further unionization efforts elsewhere.

U.S. Labor Market:  In contrast with the post-pandemic “Great Resignation,” when employers reported big jumps in voluntary quits, the softening white-collar labor market has now pushed turnover down steeply.  The latest JOLTS report from the Labor Department shows the quits rate is now back down to where it was just before the pandemic.  As a result, some businesses are over-staffed, which will heighten the risk of bigger layoffs as the economy slows.

• In a further sign of softer demand for white-collar workers, major consulting firms such as McKinsey and Bain & Co. say they are freezing starting pay for new graduates they will hire in 2024.
• Nevertheless, the firms continue to pay rich salaries to new employees. McKinsey, for example, offers a base pay of $192,000 per year for fresh MBA graduates.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are surging due to the employment data, and Victor Wembanyama has proved that being tall and mobile makes it easier to score points in basketball. Today’s Comment begins with a discussion on how central bank policy impacts bond yields, examines a new rift over government funding, and concludes with a preview of the Xi-Biden meeting. As always, our report also includes a summary of the latest domestic and international data releases.

Will Rates Stay Down? Declining interest rate expectations have caused longer-duration U.S. Treasury yields to fall.

• Investors seem confident that central banks have finished raising interest rates, with four of the five G-7 rate-setting bodies holding rates unchanged in the past 10 days. The European Central Bank, Federal Reserve, Bank of Canada, and Bank of England have signaled that policy rates may already be sufficiently restrictive to bring down inflation and will take a wait-and-see approach before raising again. This comes after central banks hiked policy rates to multi-decade highs in an effort to restore price stability. The more accommodative stance is due to concerns about a recession as PMI manufacturing readings show that economic output in G-7 countries has slowed.
• This shift in sentiment has increased investors’ appetite for longer-duration assets, such as fixed income and growth stocks. The yield on the 10-year Treasury, a benchmark for global asset prices, has fallen by more than 30 basis points over the last two days, one of the biggest drops since the regional banking turmoil in March. Furthermore, the drop in interest rates also supported an equity rally, with the S&P 500 and Nasdaq Composite rising 3.0% and 3.5%, respectively, since the Fed’s rate decision. Investment-grade bonds also reflected this risk-on behavior, with the Markit CDX North American Investment Grade Index, a gauge of credit risk, falling the most in 10 weeks.

• While central banks have paused rate hikes, this does not signal a readiness to pivot. The Fed has cited tight financial conditions as a reason to keep rates steady, suggesting that policymakers may delay easing even if conditions improve. The recent rally in global bonds means that borrowing costs are starting to fall, thus paving the way for more lending. Moreover, core inflation remains above target in many countries, and progress could be reversed if demand starts to pick up. It is important to remember that bondholders were wrongfooted earlier this year; thus, investors shouldn’t rule out another head fake.

Bidenomics Pushback: New House Speaker Mike Johnson (R-LA) is preparing for a confrontation with the Biden administration over the president’s flagship legislation.

• The U.S. House of Representatives passed a bill on Thursday to provide $14.3 billion in aid to Israel and cut funding for the Internal Revenue Service. Despite its slim chances of passing the Senate or surviving a White House veto, the bill signals a shift in stance as the two parties prepare for another round of talks on the U.S. government budget. The move to tie military aid to spending cuts is an unusual gambit, given that providing assistance to allies has typically been bipartisan and without conditions. However, Johnson’s latest ploy will likely further divide Congress as the two sides look to prevent a government shutdown on November 17.
• Johnson’s insistence on spending cuts suggests that Republicans’ ultimate strategy in budget talks is to rein in the recent spending packages passed by Congress. The Inflation Reduction Act’s $80 billion increase in funding for the IRS was designed to give the agency more tools to pursue tax evaders. According to the Congress Budget Office, the investment should increase government revenue by approximately $200 billion and lead to a net deficit reduction of $114 billion over 10 years. Its inclusion in the IRA passed in 2022 was designed to offset much of the increased deficit spending included in the legislation. As a result, the lack of funding suggests that Democrats will have to find cuts elsewhere if they want to keep initiatives intact.

• Controlling the federal budget deficit is likely to play a key role in the upcoming presidential elections. Over the past five years, the country has seen an unusually sharp rise in spending due to the pandemic response, funding for clean energy, and tax cuts. The position by House Speaker Johnson suggests that he plans to push for more spending cuts to resolve the budget shortfall, while Democrats in the Senate are likely to push for tax increases to fill the gap. The upcoming elections could hinge on whether the country is willing to give up Trump’s tax cuts, which expire in 2025, or fund Biden’s energy transition, which will require significant spending in 2024.

U.S. and China Face Off: Leaders of the largest economies are set to meet in San Francisco on Monday in an effort to dial back tensions.

• The two leaders will focus on the deteriorating U.S.-China relationship, which is evident in China’s growing assertiveness in the Indo-Pacific, close ties to Russia, neutral stance on the Israeli-Palestinian conflict, and other issues. While the meeting is unlikely to produce any breakthroughs, the hope is that it will allow the leaders to put their differences on the table and prevent miscalculations that could lead to conflict. Last week, President Biden reaffirmed the U.S. government’s commitment to defending the Philippines in the event of an attack by China in the South China Sea. Beijing responded by warning the United States to stay out of other countries’ affairs.
• Despite factions in both countries that favor cooperation, the U.S. and China appear to be drifting apart. American companies still rely heavily on China for sales growth. For example, Apple (AAPL, $177.57) shares fell 3.0% after reporting weak sales in China, the world’s second-largest economy. At the same time, Chinese factories could lose market share to foreign competitors due to U.S. reshoring efforts. Nevertheless, the de-risking trend is accelerating as evidenced by the 14% decline in Chinese holdings of U.S. Treasury securities and the sharp drop in U.S. imports of Chinese goods and services to their lowest level since late 2020.

• The divorce between the world’s two largest economies is likely to unfold over the next few years, with the biggest impact on large companies with significant revenue exposure abroad. Small and medium-sized businesses, which are typically domestically focused, are somewhat insulated from the uncertainty surrounding the U.S.-China relationship. However, countries such as Mexico and Poland are well-positioned to take advantage of the shift as they have the manufacturing capacity and skilled labor needed to fill the output void from companies looking to reduce their reliance on China.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a great start and the Texas Rangers are the new World Series champions. Today’s Comment starts with a discussion about the latest FOMC meeting, followed by our thoughts on the dollar, and an update on the bomb cyclone that is expected to make landfall in Europe. As always, our report includes an overview of the latest domestic and international data releases.

No More Hikes? Markets bet on peak policy rates after the Federal Open Market Committee (FOMC) voted to hold rates at a 22-year high.

• Fed policymakers held rates steady at 5.25% to 5.50% at their October 31-November 1 meeting, citing concerns about tighter financial conditions. The announcement comes just over a week after the 10-year Treasury yield exceeded 5% for the first time since 2007. At the press conference, Fed Chair Jerome Powell reiterated the central bank’s commitment to a 2% inflation target and said it remains prepared to raise rates if economic conditions warrant, adding that officials are not considering cutting rates anytime soon. However, he said the committee expects the economy to show signs of weakening as interest rates take hold.
• Markets cheered Powell’s remarks, with the S&P 500 closing up 1.0% on Wednesday and bonds rallying across the curve, with the yield on the 10-year Treasury falling 18 bps. Though some of the sentiment was driven by the Treasury’s decision to slow the pace of long-dated bond issuance, there was also hope that the Fed officials were finished with their hiking cycle. The CME FedWatch Tool now projects an 84.5% chance of steady rates in December and a nearly 70% chance of a rate cut by June 2024, up from 69.1% and 50.6%, respectively, last week.

• The Federal Reserve will keep its options open over the next few months, but all signs suggest it is done raising interest rates. Policymakers are likely to focus their efforts on making sure that rates do not remain too high for too long and begin impacting the real economy. So far, the Fed has been fortunate in keeping rates high for a sustained period without any negative consequences. However, it is unclear how long this good luck will last. Current default rates suggest that the default spread should be wider, indicating that investors are not adequately pricing in risk. This may change as more debt approaches maturity and needs to be refinanced at higher interest rates.

Greenback’s Resistance: After months of persistent growth, momentum in the U.S. dollar is showing signs of waning.

• Technical analysis shows that the U.S. Dollar Index has breached its 20-day moving average of 106.25, suggesting that the dollar trend may be close to reversing. The index has hovered in the 106-107 range over the past month, lacking upward pressure as market participants anticipate that central banks around the world are entering a new phase in their monetary policies. This lack of exchange rate movement comes as the market grows more confident that the policy rate differential between the Federal Reserve and its peers will not widen over the next few months.
• Over the past week, policymakers have signaled their reluctance to outdo the Fed in dovishness. The European Central Bank, the Bank of England, and the Bank of Canada all voted to hold rates steady for the second consecutive meeting, while the Bank of Japan took steps toward policy tightening. This cautious approach to a policy pivot reflects concerns that inflationary pressures may return if policymakers ease prematurely. Swap markets show that most central banks are expected to hold rates steady until the end of the year but may hike again in the first quarter of 2024.

• Historically, the Federal Reserve has hiked and eased more aggressively than its peers, suggesting that if the Fed is indeed done, then the downtrend in USD may start to take hold. This trend could benefit international equities as it should ease the debt burden and inflation pressures of countries that have exposure to the dollar. That said, investors should not become complacent as persistently strong economic data could lead the Fed to restart its hiking cycle, which would lead to renewed strength in the dollar. A weak jobs report on Friday should be enough to convince investors of a sustained trend, but another upward surprise may encourage investors to await more guidance from the Fed before abandoning their USD positions.

European Bomb Cyclone: A rapidly intensifying storm heads toward Europe this week, compounding its economic woes.

• Extreme Storm Ciarán is expected to make landfall in Britain first, becoming the first major country to be hit by the storm. The U.K. Met Office has warned of violent winds and possible flooding in several areas in the country. Afterward, the storm is expected to make its way to France carried by a “sting jet,” which is expected to lead to severe winds with speeds up to 130 km/h. Meanwhile, southern European countries such as Spain and Portugal are also expected to be impacted by strong winds. The storm has led to preemptive measures such as school closures as they prepare for the storm’s potential damage.
• These adverse weather conditions are coming at a bad time for Europe. Despite better-than-expected inflation data in October, with CPI falling below 3% for the first time since August 2021, economic activity in Europe has started to slow. GDP growth for the third quarter contracted at a seasonally adjusted annual rate of 0.1%, driven by a sharp decline in exports. The storm will likely lead to further economic disruptions, but any necessary rebuilding from the destruction could lead to a pickup in activity.

• Natural disasters are typically detrimental to local areas as opposed to the overall country, but the impact may vary depending on the event. There are several factors that influence the possible scale of the weather event, including the magnitude and duration of the event, the structure of the local economy, the population base, and the time of day the event occurs. That said, even in the case of major events, costs are typically overstated. In short, this storm may cause short-term disruptions, but it is unlikely to have a lasting impact on the growth prospects of Europe.

Other news: President Biden has asked the Israeli government to halt its forces to help with the hostage situation. The announcement highlights the potential risks of violence escalating throughout the Middle East.

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