2023 Weekly Update

Market update

The S&P 500 closed the week at 4,288.05, -0.74% lower. The Dow Jones closed at 33,507.50, -1.34%, with the Nasdaq higher by +0.06%. The volatility index VIX closed the week at 17.52 up from 17.20. The Euro Stoxx 600 slipped -1.40%.

The 10-year UST closed at 4.57% up from 4.43% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -88bps. US Corporate Bond spreads: Investment Grade widened 5bps at 188bps and High Yield widened 20bps at 432bps. German 10-year Bunds yield closed at +2.84% up from +2.74% a week before. In Europe, Corporate Investment Grade spreads widened 7bps at 168bps and High Yield spreads widened 12bps at 437bps.

The US Dollar Index (DXY) appreciated +0.56% last week and closed at 106.17. The Euro closed at 1.0573 (-0.75%); the Yen depreciated -0.67%, closing at 149.37 and the Swiss Franc depreciated -0.96%, closing at 0.9153. Gold closed at $1,848.63 depreciating -3.98%. Oil was higher, Brent closed at $95.31 (+2.19%) and WTI at $90.79 (+0.84%).

Macroeconomy

US inflation

Headline August PCE (Personal Consumption Expenditures) index, which in its broad measure rose marginally in August to 3.5% annually from 3.3% previously. However, the core PCE , which excludes volatile sectors such as energy and food and is the sub-index the Fed closely monitors, slowed to 3.9% from 4.3% annually, the slowest pace in about two years. On a monthly basis, overall PCE rose 0.4% in August from July, following a +0.2% increase earlier - mainly due to higher gasoline prices. Similarly, the core PCE posted a marginal acceleration of 0.1%, slowing from the 0.2% monthly acceleration that preceded it. The most positive thing is that there were no big surprises in the data. The core PCE suggests that inflation continues to slow, which means the Fed's aggressive policy is working but the problem that draws everyone's attention is that it remains at almost double the Fed's 2% target, which is pushing the Fed to keep the possibility of another rate hike alive. At the same time, US consumer spending - accounting for two-thirds of total economic activity - rose at a 0.4% pace in August, while the July data was also slightly revised up to a 0.9% increase from the initial 0.8%. Of course, part of the increase in consumer spending last month reflected higher prices in some categories, especially gasoline, which moved sharply higher. Indicatively, the price of gasoline reached $3.984 a gallon in the third week of August, up from $3.676 during the same period in July. Consumer confidence in the US showed a marginal improvement in September compared to preliminary data released earlier in the month but declined compared to August. Specifically, the consumer confidence index compiled by the University of Michigan strengthened to 68.1 points from 67.7 earlier this month but slipped from 69.5 in August. The index had climbed to a two-year high in July before retreating. Rising gasoline prices and interest rates have negatively impacted consumer confidence. The index of current consumer conditions slipped to 71.4 points for September.

Inflation in Europe

Euro Area September HICP came in below expectations at 4.3% y-o-y (vs 4.5% expected), down from 5.2% in August, while core inflation came in at 4.5% (vs 4.8% expected and 5.3% in July). Notably, the ECB’s estimate of the seasonally adjusted monthly core inflation rate was +0.1% m-o-m, its lowest since spring 2021. The inflation drop was broad-based, with all price categories growing at a slower pace and energy prices falling outright for a fifth consecutive month. This new evidence of slowing inflation momentum were likely to strengthen the ECB's conviction that it had raised interest rates far enough to bring down inflation to its 2% target by 2025, after being wrong-footed by a surge that started in 2021. A separate report showed German import prices - which tend to lead consumer prices because Germany sources many intermediate products and raw materials from abroad - recorded in August the largest y-o-y decline since November 1986. German retail sales fell in August and unemployment rose in September, data showed earlier on Friday, confirming the Euro zone's biggest economy may be heading for its second recession this year.

US housing

Latest data releases on US housing paint a divergent picture. On the one hand, new home sales fell to an annualized rate of 675k in August (vs. 698k expected). That’s the lowest they’ve been in 5 months, and the -8.7% decline on the previous month was the largest since September 2022. But on the other hand, the July house price data showed faster-than-expected growth. For example, the S&P CoreLogic Case-Shiller 20-City index was positive for a 5th consecutive month, at +0.87% (vs. +0.70% expected), which took the year-on-year number back into positive territory for the first time since February, at +0.13%. Meanwhile, the FHFA house price index was up +0.8% in July (vs. +0.4% expected).

Highlights

On rates

The credit market suffered from the sovereign bonds yield increase in September. Yields jumped sharply as budget deadlines approached in the US and central banks signaled rates would remain elevated well into 2024. This spike was further driven by concerns over how higher oil prices may impact inflation. The 10yr Treasury yield (+13.7bps) climbed to a new cycle high of 4.57% and 30yr Treasury yields also moved up +17.5bps to a new cycle high of their own at 4.70%, which is their highest level since 2011. We can see how that’s increasingly being passed through to the real economy as well, since the MBA’s weekly update of 30yr mortgage rates climbed another 10bps to 7.41%. That’s their highest level since December 2000, and one that’s likely to go higher still given the recent move in rates. Real yields again drove much of the increase, with the 10yr real yield up to a post-GFC high of 2.26%. But we also saw a fresh rise in inflation breakevens, with the 30yr up to a 6-month high of 2.39%, not least as the upward march in oil prices regained steam. This sovereign bond sell-off was evident in Europe too, where the 10yr bund yield (+9.9bps) closed at a new post-2011 high of 2.84%, along with the 10yr French OAT (+11.2ps) at 3.42%. Italian BTPs underperformed once again, however, with the spread of 10yr Italian yields over bunds widening to 195bps, its highest closing level since the banking stress in March. That spread widening came ahead of the Italian government unveiling its 2024 budget yesterday evening, which foresees a 4.3% deficit next year as a share of GDP. The corporate credit picture has deteriorated more recently, with spreads widening especially among the lowest rated issuers. While corporate resilience has impressed so far this year, the coming refinancing wall looks set to pose challenges. With US high yield borrowing costs close to 9%, the strain is surely building. Indeed, US high yield spreads widened by 30 basis points over the last two weeks, even as oil prices increased. Generally favorable for the energy sector, which accounts for 12% of US high yield bond index, rising oil prices have not prevented the high yield spreads widening, as concerns over high refinancing costs take hold. In the US, high yield defaults jumped to 4.75% in August from 4.5% previously. Both high yield bonds and loans drove up August’s default rate. However, leveraged loans appear to be more vulnerable given their floating rate nature, with a default rate of 4.9% last month. Moody’s rating upgrades vs. downgrades have also slipped further into negative territory in the US, a warning sign for rising default rates.

What to watch

• Monday: Japan Tankan Indexes (Q3); Eurozone Unemployment Rate (Aug.); US ISM Manufacturing (Sep.); Switzerland Retail Sales (Aug) & PMI Manufacturing (Sep.)
• Tuesday: Switzerland CPI (Sep.); US JOLTS (Aug.); Bank of Australia Decision
• Wednesday: Eurozone Retail Sales (Aug.); US ADP Employment (Sep.), Factory Orders (Aug.), ISM Services (Sep.); Bank of New Zealand Decision
• Thursday: US Trade Balance (Aug.) & Initial Jobless Claims (Sep 30); Germany Trade Balance (Aug.)
• Friday: Germany Factory Orders (Aug.); Eurozone EU Leaders Summit; US Nonfarm Payrolls & Unemployment Rate (Sep.); Bank of India Decision