Market Review 10/2021

Until the end of the year at least, inflation is likely to be the factor for investors. Looking further ahead, however, we would like to believe that the sustainability of price growth would also be affected by consumer wage growth. Macroeconomic indicators are beginning to point to slower economic activity, which could slow down inflationary pressures.

CPI data challenges Federal Reserve stance

With rising consumer prices, the pressure on the Fed is increasing, threatening their posture on inflation being transitory. Moreover, at the end of October the head of the ECB acknowledged that inflation was stable and would probably remain so. This is not supportive for government bonds, which are most exposed to rising interest rate risks. Nevertheless, risk premiums on corporate bonds remain unchanged, both for investment and speculative grade bonds of developed countries, while the rise in emerging markets high-yield bond market risk premiums is noteworthy. Although this may seem paradoxical, the worst performers since the end of the summer are both the lowest and the highest risk bond indices.

Over the past few months, emerging markets bonds were under pressure due to persistent and rising inflation. In addition, short-term debt securities in October began to see an effect of expected reduction in the US Federal Reserve’s bond purchases program, as well as an expected increase in interest rates next year. This has led to a sharper rise in short-term government bond yields in recent weeks compared to the longer end bonds. This process, called the smoothing of the yield curve, is usually the first indicator of a slowdown in economic growth.

European and US equity markets

Equity indices see new records

Even if the markets were worried about the effect of the gradual winding down of the QE program, they clearly forgot about it in October. The month will be remembered by new all-time highs for US and European equity indices. For example, the S&P 500 futures price in October rose 8%, while the Nasdaq 100 showed a 10% gain; French CAC 40 rose almost 6%, while Eurostoxx 600 gained 4.6%.

All this is happening against the backdrop of strong earnings reports for the third quarter. So far, about 60% of companies from the S&P 500 index have filed in their quarterly reports, of which two-thirds have reported better than expected earnings, and 82% of those companies reported higher earnings per share (EPS) than analysts’ expectations.

Benchmark 10-year bond yields

US and Europe look strong, China lags

China’s factory activity shrank for the second month in in a row being negatively impacted by high raw material prices as well as lower domestic demand. Services sector in October showed growth although at a slightly lower pace than in September – the official non-manufacturing PMI decreased to 52.4 in comparison to September’s 53.2 according to the National Bureau of Statistics. The official composite PMI for October, which includes both manufacturing and services activity, decreased to 50.8 compared to 51.7 in September. Consumer spending remains weak as the government has imposed tighter restrictions on travel and social gatherings.

Eurozone manufacturing activity was strong but slightly eased from September levels as input prices were soaring. Supply chain issues and rising inflation particularly hit French, German and Spanish factories. Rising costs and supply-chain constraints keeps pressure on Eurozone business activity – in October IHS Markit’s Flash Composite PMI decreased to a six-month low of 54.3 compared to 56.2 in September.

US business activity showed a solid increase in October – IHS Markit’s flash US Composite PMI Output Index (tracking the manufacturing and services sectors) increased to 57.3 in the first half of October from 55.0 in September. The increase in business activity was driven by the services sector – IHS Markit’s flash services sector PMI increased to 58.2 from 54.9 a month ago. The number of Americans filing new claims for unemployment benefits dropped to a 19-month low.

High Yield bond Indexes

No surprises from the Fed

FOMC’s meeting in the early November went as expected. Fed announced that tapering of bond purchases would start “later this month”. The process will see reductions of $15 billion each month from the current $120 billion a month that the Fed is buying. Regarding the inflation, Fed keeps insisting that the surge in it is ‘largely’ transitory, which suggests the doves still set the tone in the Committee. Needless to say, FOMC voted not to raise interest rates. Markets reacted positively, with S&P futures stretching further to the 4660 mark.

Gold price, USD/oz