By Benjamin Picton, Senior Macro Strategist at Rabobank
US equities rose again yesterday to mark the seventh-straight session of gains. Stocks shook off an early dip and another soft lead out of Europe where only the German DAX closed higher by 0.11%. Crude oil sold off sharply and Asian stocks also came in for a battering. The Nikkei was off 1.34%, the Hang Seng was down 1.65% and the ASX200 was again a paragon of low volatility, easing by just 0.29%.
The ASX was bolstered by an RBA rate hike that we took as dovish. The cash rate target was lifted by 25bps to 4.35%; the first rise since June of this year. We had been forecasting a November rate rise since early August, having anticipated that the Q3 inflation report would prove spicier than the RBA’s own internal assumptions.
With the hike now delivered, we think the RBA is done for the time being. We get the sense that Governor Bullock, didn’t actually want to raise rates but had little choice after painting herself into a corner by saying that the central bank had a “low tolerance” for any delays in returning inflation to target, and that they “won’t hesitate” to tighten again if there was a “material” upward revision in inflation.
Bullock’s position was made more difficult after the Federal Treasurer gave a press conference declaring that the hot Q3 inflation report didn’t qualify as ‘material’. That gave the impression of political interference, leaving the Governor little choice but to assert her independence or else begin her term with another credibility hit for a central bank already running low on credibility.
The problem with the dovish hike is that it has prompted the market to loosen financial conditions. In this respect, the RBA has repeated the Fed’s mistake of last week where Jerome Powell signalled that the Fed might be finished because higher bond yields had done the tightening for them. Traders duly bought bonds, and much of the tightening was therefore unwound. The FT this morning reports that Goldman Sachs estimates the cumulative effect of recent falls in bond yields to be equal to two Fed cuts.
Unlike the RBA, the Fed seems to have learned their lesson. Just about every Fed speaker and was hitting the airwaves yesterday with assurances that the Fed could hike again. Michelle Bowman told us that she “continue[s] to expect that we will need to increase the federal funds rate further”, Lorie Logan said inflation remains too high and “it looks like we are trending toward 3%” (rather than 2%), and Neel Kashkari reprised his act from a day earlier by telling us that “we have to get inflation back down to 2%” and that he is “not seeing a lot of evidence that the economy is weakening.”
Christopher Waller provided a voice of dissent as he described the rise in Treasury yields since late July as an “earthquake” and noted that the move is capturing a lot of attention. Of particular interest is the ‘term premium’, described by Kashkari as “the residual of all the stuff we can’t explain.” Our rates team has been following these moves for several months and made the suggestion in late September that term premia is best understood as the compensation that investors demand for uncertainty and is unrelated to the future expected path of short rates or inflation expectations.
Investors could be forgiven for demanding higher compensation for uncertainty. We now regularly hear that the geopolitical situation is the most fraught since WWII. Israeli Defence Minister Yoav Gallant announced this morning that IDF troops have reached the heart of Gaza City, and that Hamas’ leader in Gaza has been isolated in his bunker. Meanwhile, Benjamin Netanyahu says there can be no ceasefire unless Israeli hostages are freed and has again warned Hezbollah against expanding hostilities in the North, even as Hezbollah’s second-in-command threatens to do just that.
Having the benefit of bitter experience, the United States has told Israel that it opposes any long-term occupation of the Gaza strip as reports emerged of comments by Israeli officials that they intend to retain security control of Gaza for an indefinite period. Israeli Foreign Minister Eli Cohen hosed down concerns by saying “we don’t want to govern Gaza…. we just want to protect our people.” The preferred exit strategy appears to be turning over administration of Gaza to an international coalition.
The makeup of that coalition is yet to be determined, but other actors are stepping up their interest in the region. Russia is expanding its military presence in Libya, and Bloomberg reports that Joe Biden has been briefed on China’s plans to build a military base in Oman. A new Chinese military facility adjacent to the Strait of Hormuz would be a major concern for the White House, raising fears that China could follow Russia’s lead in exerting pressure on the West through interruption to the flow of energy supplies.
While geopolitics provides a troubling backdrop, China has economic troubles of its own. October trade balance figures released yesterday revealed that exports fell more than expected to be down 6.4% y-o-y, but imports surged from last month’s negative print to record year-on-year growth of 3%. The recovery in import activity could be a sign that Chinese stimulus efforts are beginning to take effect even as Xi Xinping is increasingly interested in improving China’s trade fortunes. The IMF duly upgraded its 2023 China growth forecast from 5% to 5.4%.
Meeting with Australian Prime Minister Albanese this week, Xi took a conciliatory approach by agreeing to review import tariffs and re-instate regular leadership dialogues while encouraging Australia to support China’s entry into the Trans Pacific Partnership. The diplomatic thaw is welcome from Canberra’s perspective. Australia has been stuck between a rock and a hard place in managing the relationship with its largest trading partner (China), while acting as a key security partner for the USA in the Asia-Pacific, and Aussie producers had been caught in the crossfire.
The geopolitical environment remains far from benign and central bankers caution of further monetary tightening, but equity markets have chosen to accentuate the positive for now. We will be watching with interest to see if US stocks can make it 8-straight later today.