Muzinich Weekly Market Comment: Drifting apart
Viewpoint
October 21, 2024
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In our latest roundup of the key developments in financial markets and economies, we look at the widening economic gap between Europe and the US and consider whether the pessimism around China stimulus is justified.
Last week was one of differentiation in financial markets. The US Treasury yield curve moved out slightly, by 1 to 2 basis points (bps). In contrast, yields on European government bonds fell significantly, by 10 to 15bps across the curve.
Credit markets had a positive week, with falling European government bond yields a key factor. This allowed euro-denominated credit to outperform, with investment-grade (IG) bonds the standout sub-asset class.
The widening interest rate differential helped lift the US dollar against global currencies, with the Japanese yen breaching the psychological 150 level for the first time since the Bank of Japan's heavy-handed intervention in July.[1] It was another tough week for commodities, as prices fell across the board in industrial metals and energy products. The exception was gold, which set a new price high, breaking through the US$2,700 per ounce level on October 18.[2]
Finally, equities had a solid week, despite intraday volatility caused by Q3 earnings announcements. The underperforming region was Asia, where both Japan’s Nikkei and Hong Kong’s Hang Seng indices closed in negative territory.
Looking for green shoots in China
China started the week on a weaker note, with poor sentiment driven by the much-anticipated weekend press conference from the Ministry of Finance (MoF). The press conference offered little in terms of headline stimulus size or detail, falling short of elevated market expectations.
However, it was later leaked by the state-affiliated publication Caixin that China may raise an additional 6 trillion yuan (US$845 billion) through the sale of Treasury bonds over the next 3 years to bolster the slowing economy with fiscal stimulus.[3]
Despite the negative reaction in some quarters, we found the press conference encouraging overall. The MoF appears to be adopting a pro-growth stance and has identified key areas of the economy to focus on. These include resolving the longstanding problem of local government off-balance-sheet debt through a debt swap programme, supporting the property market by purchasing homes and land, and recapitalising banks. And, although the conference lacked details on consumer stimulus, Finance Minister Lan Foan made a telling remark about keeping its options open for further fiscal measures, while also stating the government has “relatively large” capacity to increase borrowing.[4]
Investors will closely monitor economic data for green shoots. However, there were no such signs from September’s loan or housing price data. Aggregate financing, a broad measure of credit in the economy, increased by 3.8 trillion yuan, down from 4.1 trillion yuan in the same month last year. Although M2 growth picked up to 6.8%, M1 growth hit a record low, contracting -7.4% year-on-year.[5]
Weak demand from consumers and corporations is weighing on these indicators, while house prices also continued to decline. According to the NBS 70 cities survey, new home prices fell by 0.7% month-on-month in September, with prices declining in 66 of the surveyed cities.[6]
More constructively, activity data suggests the economy gained momentum towards the end of Q3, with growth accelerating 0.9% quarter-on-quarter, up from 0.5% in Q2.[7] Year-on-year, growth reached 4.6%, just beating the consensus estimate of 4.5%. Perhaps of more relevance, monthly activity data for September surprised positively across the board, with industrial production, fixed asset investment and retail sales all exceeding expectations. This, along with monetary and fiscal stimulus, has raised hopes that China will achieve its 5% growth target for the full year.
Moving in opposite directions
Inflation in Europe continues to decline. In the UK, headline consumer prices fell to 1.7% in September, down from 2.2% in August and below the consensus expectation of 1.9% and the Bank of England's (BoE) year-end forecast of 2.1%.[8] Service prices also dropped more than anticipated, decreasing to 4.9% from 5.6% — the BoE had projected a year-end reading of 5.5%.
While inflation is likely to re-accelerate in the final months of the year, driven by rising household energy bills, the BoE seemingly has the green light to cut policy rates by 25bps at the November meeting of its Monetary Policy Committee.
In the Eurozone, September inflation was revised downward to 1.7% year-on-year, with prices falling -0.1% during the month.[9] This data release was timely, coming on the same day as the European Central Bank (ECB) cut interest rates for the second consecutive meeting — the first time this has happened since 2011— reducing its key policy rate from 3.5% to 3.25%.[10]
With low growth becoming a much bigger concern for the ECB than inflation, markets anticipate it will ease policy again at its next meeting in December and potentially in January, too.
In contrast, the key data release from the US was retail sales, which came in strong. Ten of the thirteen categories posted increases from the previous month, indicating consumer spending continues to drive the economy above trend. The control group, which feeds into the government's GDP calculation, surged 0.7% month-on-month, more than double the consensus forecast of 0.3%.[11]
Following the data release, the Atlanta Fed’s GDPNow model adjusted its Q3 US growth projection to 3.4%, which would mark the economy's strongest pace this year.[12]
Given the growing divergence between their respective economies, it was unsurprising to see European and US government yields moving in opposite directions, as our chart of the week illustrates.
Chart of the week: Difference between 5-year German Bund and US Treasury yields (per cent)
Source, Bloomberg, as of October 18, 2024. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
References
[1] Bank of Japan, Change in the Guideline for Money Market Operations and Decision on the Plan for the Reduction of the Purchase Amount of Japanese Government Bonds,’ July 31, 2024
[2] Bloomberg, ‘Gold price tops $2,700 for first time to extend record-breaking run,’ October 18, 2024
[3] Caixin Global, ‘Weekly Must-Read: China May Add 6 Trillion Yuan in Treasury Bonds to Buttress Economy,’ October 18, 2024
[4] Reuters, ‘China stimulus aims at its greatest wall of debt,’ October 14, 2024
[5] People’s Bank of China, ‘Financial Statistics Report Q1-Q3 2024,’ October 14, 2024
[6] National Bureau of Statistics of China, ‘Sales Prices of Commercial Residential Buildings in 70 Medium and Large-sized Cities in September 2024,’ October 18, 2024
[7] National Bureau of Statistics of China, ‘National Economy Showed Stable Growth Trend with Positive Factors Accumulating in the First Three Quarters,’ October 18, 2024
[8] Office for National Statistics, ‘Consumer Price Inflation – September 2024,’ October 16, 2024
[9] Eurostat, ‘Inflation in the euro area,’ October 17, 2024
[10] European Central Bank, ‘Monetary Policy Statement,’ October 17, 2024
[11] US Census Bureau, ‘Advance Monthly Sales for Retail and Food Services,’ October 17, 2024
[12] Federal Reserve Bank of Atlanta, ‘GDPNow Forecast,’ October 18, 2024
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