Whipsawed by policy makers

In September, investors were buoyed by the prospect of global policy easing. However, this enthusiasm waned in October as policymakers deliberated on their next moves. This uncertainty has led to an increase in U.S. Treasury (UST) yields and has kept equities under pressure. Despite the rise in bond yields, gold has emerged as a standout asset, reflecting its traditional role as a safe haven in times of uncertainty. Investors are now holding their breath as the U.S. elections approach, an event that could significantly influence global policy and economic trajectories in the coming years.

Initial rush of policies turns into a test of patience

In the United States, fears of an impending recession were quickly dispelled following the release of September's job data. The market's expectation for a stable economy was reinforced by a decline in the unemployment rate and robust retail sales figures. The economy expanded by 2.8% quarter-over-quarter (q/q) in the third quarter of 2024, with consumer spending and business investment providing crucial support. This positive economic data aligns with the Federal Reserve’s (Fed’s) recent stance, suggesting that there is room to cut interest rates at a more measured pace, rather than the aggressive 50 basis points (bps) cut seen in September. The futures and overnight index swap markets have already adjusted to this more moderate outlook, anticipating only a 25 basis points (bps) cut in each of the upcoming November and December meetings.

The prospect of less aggressive Fed rate cuts in the coming months has contributed to the rise in UST yields. The 10-year UST yield climbed from a recent low of 3.6% in mid-September to a high of 4.3% in October. Beyond the macroeconomic environment, the potential for a Republican administration, supported by a Republican-controlled Senate and House, has also captured investors' attention. This political scenario suggests a sustained increase in fiscal debt over the medium term, translating into a higher premium on UST yields.

In China, a series of policy measures announced by the People's Bank of China and financial regulators initially boosted market expectations for a more aggressive stimulus. However, subsequent press briefings by the National Development and Reform Commission (NDRC) and the Ministry of Finance have not provided the detailed policy guidance that investors are seeking, leading to some market corrections. All eyes are now on the upcoming National People's Congress Standing Committee meeting, scheduled for November 4-8, where more implementation details are expected to be unveiled.

The potential for increased debt issuance could help address local government debt issues and provide local authorities with more fiscal space to spend. This could also lead to more resources being allocated to address the excess supply in the housing market, potentially converting surplus housing into public housing. Both fiscal and monetary stimulus are crucial for revitalizing the Chinese economy, but another key factor is improving household and business confidence. Achieving this may require long-term reforms in social security and efforts to enhance the business environment for emerging industries and services.

Elections still dominate the headlines, and not just in the U.S

Many investors are postponing their investment decisions, awaiting the outcomes of the U.S. presidential and congressional elections. However, the U.S. is not the only country holding significant elections this year. In Japan, the newly inaugurated president of the Liberal Democratic Party (LDP), Shigeru Ishiba, called for a Lower House election on October 27. The LDP's popular support has suffered following a series of party expense scandals, leading to its ruling coalition with Komeito losing its majority for the first time since 2009. Opposition parties, such as the Constitutional Democratic Party, Japan Innovation Party and Democratic Party for the People have gained seats.

At the time of writing, Prime Minister Ishiba has yet to form a new coalition. The current policy stalemate suggests that a decade of corporate reform is likely to continue on autopilot. Meanwhile, the incoming ruling coalition, whether led by the LDP or another party, may prioritize economic growth to regain popular support. This could result in tax increases being deferred for the time being.

In the U.S., while the outcome of the presidential election could influence policies on taxes, immigration and trade, among other areas, several trends are expected to persist regardless of who wins the White House. The U.S. Federal government debt is likely to continue rising due to the lack of political will to significantly increase taxes, coupled with limited room to cut spending, especially on essential services such as health care, Social security and education.

The ongoing shift in the global supply chain is also expected to continue. The U.S. is seeking to reduce its dependence on Chinese imports, a sentiment echoed by European countries. This could lead to increased manufacturing capacity in other emerging economies, such as those in Southeast and South Asia, Mexico and Central and Eastern Europe. This shift implies a greater demand for infrastructure and transportation development.

Investment implications

It is understandable that investors may prefer to wait for clarity from the U.S. elections before making significant changes to their portfolio allocations. However, we believe that economic fundamentals and the outlook for monetary policy will underpin the long-term performance of markets. Our expectation of an economic soft landing, combined with monetary easing, continues to bode well for risk assets, including equities and corporate credits, as we approach the new year. Many long-term themes, such as the hardware supporting the artificial intelligence boom and the ongoing diversification of the global supply chain, should remain positive factors supporting Asian tech exporters, as well as infrastructure and business services.

Global economy:

• The U.S. soft landing narrative continues, with September retail sales beating expectations and October ADP payrolls higher than consensus (most robust hiring since July 2023). The September consumer price index (CPI) inflation was at 2.4% year-over-year (y/y), marking the slowest annual increase since early 2021, raising worries of slowing disinflation momentum. We continue to expect rate cuts in November and December, as the U.S. labor market continues to cool. Although the October non-farm payroll report is affected by weather/strike impacts, downward revisions to August and September numbers continue to indicate softening labor demand.
  (GTMA P. 31, 32, 33)
• China’s 3Q gross domestic product (GDP) expanded by 4.6% y/y, beating expectations of 4.5%. September activity data was also generally better than expected. While property market weakness remains a key overhang, improvements were seen in retail sales in autos and household appliances on the back of government trade-in programs. October manufacturing PMIs from both Caixin and NBS also returned to expansion territory. However, inflation data continue to disappoint, with headline CPI in September rising 0.4% y/y, a three-month low, and core inflation was flat at 0.1% y/y growth. Various government press conferences continue to confirm the commitment to support fiscal expansion and property markets, while loan prime rates were cut by 25 bps, in line with the central bank’s guidance. We continue to look to the November Standing Committee of the National People's Congress meeting for more details on stimulus measures.
  (GTMA P. 5, 9, 10)
• In Japan, Ishiba was named Prime Minister, but with ruling Liberal Democratic Party’s coalition experiencing the first Lower House elections defeat since 2009. The Bank of Japan held policy rates at 0.25% as expected but struck a hawkish tone overall. Elsewhere in Asia, central banks in Korea, Philippines and Thailand cut benchmark rates.
  (GTMA P. 23, 24)

Equities:

• Equities were generally weaker in October, with global markets down 2.3%. The S&P 500 fell 1%, driven mainly by higher rates and uncertainties ahead of the U.S. elections. Emerging markets underperformed developed markets, returning -4.4%. Asia Pacific ex-Japan in local currency terms was especially weak at -4.9%, driven by a stronger U.S. dollar and the equity pullback in China
  (GTMA P. 36)
• After the September-end rally in the Chinese market, CSI 300 fell 3.2% while MSCI China fell 6% on the back of uncertainty over the size and efficacy of the stimulus announced. However, year-to-date, the two indices are still up 13.4% and 18.6%, respectively. TOPIX returned a positive 1.9%, despite uncertainties surrounding election results, the Japanese yen (JPY) and tighter monetary policy.

Fixed income:

• Government bond yields moved up aggressively over October, as investors dealt with the uncertainty over the outlook for inflation and growth post the U.S. elections. The 10-year yield rose by 50 bps to 4.28%, and the two-year yield rose by 52 bps to 4.16%. A resilient economy in the form of a strong labor market and slower than expected deceleration in inflation had the market paring back its expectations on the size of interest rate cuts at the remaining U.S. Fed policy meetings this year.
  (GTMA P. 63, 64)
• Credit markets suffered along with equities as the rise in yields pushed prices lower. Despite narrowed spreads, U.S. investment grades and high yields have returned -2.4% and -0.6%, respectively.
  (GTMA P. 62)

Other financial assets:

• The U.S. dollar strengthened over the month, as investors weighed the outlook for both the interest rate differential and the growth differential between the U.S. and the rest of the world. The DXY was 3.1% higher over the month, with large gains against the JPY (+6.5%), the British pound (4.2%) and the euro (2.7%). The lowering of Fed rate cut expectations and the likely need for more aggressive easing policy in the UK and across the eurozone weighed on the euro and the pound. The outcome of Japan’s Lower House election meant that the Bank of Japan may delay further rate hikes until market volatility is lower.
  (GTMA P. 74, 75)
• The Bloomberg Commodities Index fell 2.2% over the month, as energy prices and industrial metals fell. Oil markets were choppy, with Brent crude rising as high as over USD 80 per barrel, before ending the month at USD 72.8. Main drivers were geopolitical concerns around an expansion of the conflict in the Middle East, but support came in the form of resilient U.S. economic data and hope for Chinese stimulus efforts to support demand.
  (GTMA P. 76, 78)

0903c02a8262e8b6