Ten-year US Treasury bond yields are approaching 5%, surpassing the level reached earlier in October before the outbreak of conflict in the Middle East. Over the last two weeks, yields did fall back as geopolitical worries led investors to take risk off the table, but recent better-than-expected US economic data has driven yields back up.
The increase in nominal bond yields has been driven not only by rising real (inflation-adjusted) yields – as has been the case since July – but also by rising inflation expectations (see Exhibit 1). This may reflect market concerns that, should Iran become involved in the Israel-Hamas conflict, it could mean higher oil prices.
US economic data, however, has not necessarily been as strong as the market appears to believe. The apparent ‘surge’ in US private non-farm payrolls data from two weeks ago is worth a closer look.
The seasonally adjusted headline figure of 336 000 jobs created (compared to the expected 170 000) included a significant amount of government hiring. The non-seasonally adjusted (i.e., actual) figure for private payrolls fell by 399 000. So private-sector employment actually declined in September, but it almost always does as summer hiring is unwound.
The decline was less than average – hence the above-average seasonally adjusted figure – but the true, non-seasonally adjusted data paints a different picture of how the labour market is doing compared to the media reports. It also makes it easier to understand why average hourly earnings growth declined from 4.3% year-on-year to 4.2% from the previous month.
The latest US inflation data was similarly presented as stronger than expected. The year-on-year change in the consumer price index (CPI) was 3.7% versus the forecast 3.6% increase. But again, the detail reveals a different picture.
For the US Federal Reserve, core inflation matters more. It rose by 0.3% on the month (as expected), but the increase was almost entirely driven by still-high shelter costs. While higher housing prices spell inflation, it is less of a concern for the Fed insofar as high mortgage rates will likely lower housing costs eventually. The latest housing starts data, for example, came in below consensus expectations. Exclude shelter from the inflation calculation and ‘core core’ inflation rose at just 0.07% on the month (1.9% year-on-year).
Aside from technical factors such as investor positioning and selling from Commodity Trading Advisor (CTA) accounts pushing up Treasury yields, market worries over large fiscal deficits are playing a role.
While we expect yields to fall from here, we acknowledge that with quantitative tightening (QT) by the Fed ongoing and Treasury supply growing, yields could yet rise higher.
China – Waiting for support to come through
Investor sentiment towards China remains poor, but the equity market has stabilised over the last few months (see Exhibit 2). Recent economic data has been (modestly) encouraging. The year-on-year change in imports and exports in September was still negative as activity globally has slowed since the initial post-lockdown boom, but at least the export growth rate was not as negative as feared.
Importantly, economic growth in the third quarter beat market expectations, with GDP growth coming in at 4.9% year-on-year versus the forecast 4.4% increase. Even more encouraging was the annualised quarter-on-quarter change at 5.2%, meaning that as long as growth is at least 3.4% in the fourth quarter (annualised QoQ), the government can achieve its 5% growth target for the year.
In our view, to see China equities outpace global equities rather than keeping pace with them, there needs to be more significant support from Beijing for the struggling property sector and measures to address high local government debt. These twin concerns are depressing domestic consumer and business sentiment as much as they are foreign interest in Chinese assets. We expect support from the powers-that-be to come through, but the timing remains uncertain.
Europe – A less attractive setting
In contrast to the US and China, eurozone data has generally been coming in below market expectations (see Exhibit 3). German sentiment as well as German and UK industrial production have all disappointed recently, though Italy’s industrial production growth was better than expected.
Inflationary pressures are waning in the eurozone, but only slowly, and we believe the European Central Bank is unlikely to signal that it will be cutting rates anytime soon.
The region is already flirting with recession. Lacking the fiscal stimulus that has so helped the US economy, and with rising natural gas prices and the Middle East conflict renewing concerns about energy prices this winter, Europe faces more negative catalysts than positive ones.