Insights

After a few weeks of disappointment, US economic data changed trajectory for the better, challenging the market view that US growth was rolling over and the Fed should resort to interest rate cuts sooner. Both the US employment numbers and the US consumer confidence survey came in better than expected. The Fed’s monetary committee meets this week. While the market is not expecting any fireworks, it will likely be hoping for a messaging that at least helps keep the current rally intact. Nevertheless, we struggle to see how the Fed could endorse such a move higher in bonds and equities when the medium-term strength of economic data is unclear.

The financial markets have maintained their recent upward run, which has been fueled by a stream of seemingly positive developments that have boosted equities and high-yield bonds. However, we caution against the current wave of optimism, which could face a sharp reversal if the widely anticipated gentle economic deceleration fails to materialise.

Last week witnessed a notable boost to investor sentiments as the 0.1% outperformance of U.S. inflation data versus expectations prompted a discernible uptick in risk appetites. The impact resonated through the global bond markets, with a significant decline in yields—U.S. 10-year notes receded by 20 basis points (bps), paralleled by a steeper 30 bps reduction in New Zealand. Equities, too, ended the week on a high, with markets generally advancing 2-4%. European and Japanese indices, in particular, benefited, eclipsing gains in the U.S. and capitalising on a concurrently retreating U.S. dollar.

We've been hearing mixed signals lately. On one hand, we're told that US equities are surging because of lower long-term interest rates and robust earnings forecasts. However, central bankers continue to express concerns about stubbornly high core inflation, vowing to keep interest rates elevated for an extended period of time. Alarmingly, a US household survey reveals that inflation expectations are on the rise, and not declining. Federal Reserve's Confounding Commentary. The commentary from Fed governors last week was, frankly, perplexing. Just days after their November FOMC meeting, Fed governors were offering intricate insights into the potential future of policy rates, which only added to the market's confusion.

Last week, volatility in the bond market was unprecedented with a peak-to-trough drop of 43bps in the US 10-year government bond yield. It would be wrong to see the move as a validation of a more positive view of the future. The fall in bond yields was the consequence of good news from policymakers and economic data. However, the scale of the rally in the bond market was exaggerated by the closing of a huge, short position in the treasury market.