Monthly Market Review - September 2024
The pivot toward growth
September 2024 marked a series of pivotal changes that could extend the risk-on rally into 2025. Both China and the U.S. have decisively shifted toward supporting growth, a move investors have been anticipating for some time. This pivot bodes well for global risk assets in the coming months. However, new risks are also emerging. The geopolitical situation in the Middle East is becoming increasingly complex, and the U.S. presidential election remains a tight race, potentially leading to short-term market volatility, especially if the results are disputed.
Go big or go home
With falling inflation and rising unemployment, the Federal Reserve (Fed) has met the conditions to start cutting rates. Opting for a more aggressive 50 basis points (bps) cut over a conventional 25 bps, the Fed has shifted its policy priority from fighting inflation to protecting economic growth and jobs. This shift is justified by the ongoing decline in inflation, with the August personal consumption expenditures deflator falling to 2.2% year-over-year. The Fed's objective is further supported by the decline in U.S. Treasury (UST) yields, which have returned to an upward slope and dropped below 4%. This should help reduce lending rates on new mortgages and corporate borrowing costs.
There are some inconsistencies in the updated Summary of Economic Projections (SEP). Historically, the unemployment rate rises consistently once it bottoms out, rather than staying just above full employment for several years as forecasted in the SEP. Additionally, why drag out 150 bps worth of rate cuts between 2025 and 2026 when this could be done over 4-6 meetings? This likely reflects the uncertainty in the longer-term prospects of the global and U.S. economy, with Fed officials focusing on aligning near-term policy with current economic needs. This also means there could still be changes in the overall path of policy rate easing. For now, Fed officials, including Chair Jerome Powell, are hinting that a more modest 25 bps cut in the November meeting is appropriate. This could still shift depending on a few risk events in the weeks ahead. For example, the port strike could disrupt supply chains and lead to a temporary squeeze on inflation. The escalation in tensions between Iran and Israel is pushing oil prices higher, which could be seen as a driver of higher inflation or a squeeze on U.S. consumers and small businesses. The Fed's short-term focus is hard to argue against given the rapidly changing economic landscape. However, this could also be a source of volatility as investors constantly adjust their expectations on policies.
Super-sized combo meal
On the other side of the world, China has finally brought out the big guns to boost its economy. On September 24, its central bank and the securities and financial regulators announced a series of measures, including interest rate and reserve ratio cuts, easing measures on the property market and steps to boost the stock market. While some of these policies have been implemented in the past, the coordinated approach across several aspects of the economy shows the authorities' urgency to support growth. These measures were followed by the Politburo meeting later in the week, where the top decision-making body also emphasized the need to support jobs and the economy. More fiscal measures could be on the cards, allowing both central and local governments more resources to stimulate consumption.
These measures, ahead of the National Day holiday, have prompted a sizable rally in the stock market. The rally's sustainability will be determined by the details of policy implementation and consumer response. The tourism and spending data over the week-long holiday could be a useful gauge. Chinese equities are now back on investors' radar.
The Fed's easing and China's policy stimulus have raised the probability of the global economy achieving a soft landing as we approach 2025. This should continue to support risk assets, including equities, high-yield corporate bonds and emerging market fixed income.
Watch what they do, not what they say
2024 has been a year of elections around the world and is set to finish strong with the presidential and congressional votes in the U.S. Japan has also announced that it will hold its general elections on October 27 after Shigeru Ishiba won the race to be the president of the Liberal Democratic Party (LDP), and hence, by default, succeeding Fumio Kishida as prime minister.
There is little doubt that the LDP can retain its majority in the parliament by forming a coalition with the Komeito Party. Prime Minister Ishiba's campaign pledges did concern some investors as he advocated for tax increases on corporate and financial income. Yet, his most recent speeches suggest he is shifting toward a more modest stance on this issue, as well as maintaining the Bank of Japan's independence.
In the U.S., the presidential race is still too close to call. In key swing states, the latest polls show that the lead of either candidate is within the margin of polling error. So, events in the coming weeks could impact swing voters' opinions and settle the race. This also means the probability of a divided government, where the White House and Congress are controlled by different parties, is on the rise. In this scenario, the next president's policy, especially on fiscal and regulatory changes, could be blocked by Congress. The president still has considerable executive power on issues such as trade policy. Historically, the period running up to the elections saw a short-term rise in volatility, but this typically fizzled out once the results were confirmed. Given how close these elections are and the mail-in ballots that could take some time to count in selected swing states, the results could take longer to finalize.
Finally, the situation in the Middle East has taken a turn for the worse. Israel's attack on Hezbollah in Lebanon prompted Iran to retaliate with missile strikes on October 1. With Iran being directly involved in the conflict, investors could worry about oil supply, especially if the transportation route over the Strait of Hormuz is disrupted. Oil prices have already reacted to this news, but ample spare capacity from the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC producers could help to provide some offset. Still, central bankers and governments around the world could see another rise in energy prices as undesirable given the impact on higher inflation, pressure on household disposable income and corporate profit margins.
What does this mean for investors?
We are firmly in a global policy easing cycle, which should help underpin risk sentiment in the medium term. While the recent market focus has been on the sustainability of the Chinese market rally, we see this as an opportunity to broaden global equity allocation as well as high-yield corporate debt. Some investors are probably still not convinced by the prospects of a Chinese economic recovery. There are proxies, such as commodities or European consumer goods, that could benefit from more upbeat Chinese consumers. These could benefit if China's economic recovery materializes but are not completely dependent on it.
Nonetheless, there is still a role for developed market government bonds and investment-grade corporate debt. These defensive assets could help provide additional portfolio stability in case of unexpected deterioration in economic growth momentum.
Global economy:
- The Fed has initiated its rate cut cycle with a 50 basis points (bps) reduction in policy rates. The revised projections indicate that the Federal Open Market Committee (FOMC) members expect policy rates to fall by another 50 bps before the end of the year and by 150 bps over 2025 and 2026. Falling inflation and a rising jobless rate have provided the central bank with the conditions to move decisively and aggressively. Since the September meeting, Fed officials have hinted at a more conventional 25 bps cut in future meetings. Meanwhile, the European Central Bank also cut its policy rate by 25 bps, as expected.
(GTMA P. 33) - Chinese authorities surprised the market with a combination of policy stimuli aimed at boosting consumption, the real estate market and the stock market. While many of these measures have been deployed before, the coordinated approach reflects Beijing’s renewed urgency to improve growth momentum. More details, especially on fiscal policy, will be crucial in sustaining market optimism, as well as incoming data reflecting consumer and business sentiment.
(GTMA P. 5, 9, 10) - Elections and geopolitical tensions are offsetting some of the positive market sentiment. The U.S. presidential election remains a very close race, with swing state polls showing the two candidates mostly within the margin of error. In the Middle East, Israel’s military action against Hezbollah in Lebanon has triggered missile strikes by Iran, escalating regional tensions. The prospect of oil supply disruption has pushed oil prices higher.
(GTMA P. 25, 78)
Equities:
- Rate cuts and steady economic data have underpinned the performance of U.S. equities. The S&P 500 was up 2% in September, and the NASDAQ rose by 2.7%. The S&P 500 ended the month at an all-time high. Large-cap stocks also outperformed small-cap stocks in September, in line with historical precedents of Fed rate cut cycles.
(GTMA P. 36) - China’s stimulus package made it the standout performer of September. Not only did it outperform the global equity market for the month, but the CSI 300’s 22% gain in USD and the Hang Seng Index’s 17.5% return have propelled these two markets to the top performers of 2024. ASEAN also delivered steady returns amid weaker performance in Northeast Asia. Japan, South Korea and Taiwan all lost ground in the month in local currency terms. MSCI ASEAN was up 6.1%.
(GTMA P. 36)
Fixed income:
- A more dovish Fed helped to bring the U.S. Treasury curve lower and back to an upward slope in the 2-10 year segment. The 10-year yield fell by 12 bps to 3.79%, and the two-year yield fell by 28 bps to 3.64%. As the market is pricing in more than 50 bps of rate cuts before the end of the year, the risk is that the Fed may deliver less than expected in the coming two meetings, prompting a short-term rebound in bond yields. More broadly, the ongoing rate cut cycle in many developed economies is pushing European government bond yields lower.
(GTMA P. 63) - The rising prospects of an economic soft landing in the U.S. have helped to keep corporate bond yields tight. U.S. high-yield corporate spreads to worst have fallen toward 325 bps, supported by low current default rates and an undemanding refinancing schedule for the rest of 2024 and 2025. Emerging market bonds have also delivered strong performance on the back of a depreciating U.S. dollar and more flexibility for emerging market and Asian central banks to cut rates in the months ahead.
(GTMA P. 62)
Other financial assets:
- The USD index was broadly stable in September, falling by only 0.9% over the month. Established central bank policy rate expectations likely helped to limit further downside for the U.S. dollar (USD). The Australian dollar, British pound and Japanese yen were the top performers against the USD. In Asia, ASEAN currencies such as the Thai baht, Malaysian ringgit and Indonesian rupiah also caught up with the USD, given their cheap valuations and room for more policy rate cuts.
(GTMA P. 74, 75) - Falling yields and a weaker USD continued to support gold, with its price reaching another record high and registering a 6% gain in September. Oil prices experienced a choppy month. Brent crude fell below USD 70 per barrel as Saudi Arabia is suggesting a shift to its production focus from supporting oil prices to regaining market share, implying an increase in production. However, at the end of the month, an escalation in Israel-Iran tensions prompted fears of supply disruption, pushing Brent crude prices back above USD 75 per barrel.
(GTMA P. 76, 78)