United States
Geopolitical concerns, a tough stance from Federal Reserve officials, and a surge in long-term bond yields to levels not seen in 16 years all seemed to impact market sentiment. The S&P 500 Index experienced its most significant weekly decline in a month. Among major benchmarks, the Nasdaq Composite Index fared the worst and came perilously close to slipping into bear market territory, finishing the week down 19.91% from its intraday highs in early 2022. Concurrently, growth stocks underperformed their value counterparts.
The week commenced positively, with the 15th consecutive Monday of gains for the S&P 500. This initial optimism stemmed from limited negative news from the Middle East over the weekend. However, escalating tensions in the region later in the week eroded these gains. On Thursday, stocks took a sharp dive following reports of a U.S. Navy destroyer intercepting a cruise missile that was apparently headed for Israel. Reports of a drone attack on a U.S. base in Iraq also weighed on market sentiment, according to T. Rowe Price traders.
Federal Reserve policymakers remained unconvinced that inflation was under control. At a real estate conference in Washington, Richmond Fed President Thomas Barkin expressed scepticism about demand slowing and cooling inflation. During a speech before the Economic Club of New York on Thursday, Fed Chair Jerome Powell initially boosted market sentiment by acknowledging a clear tightening of financial conditions. However, markets retreated sharply when Powell stated that he saw no signs of Fed policy pushing the economy into a recession.
Some better-than-expected economic data fuelled concerns that interest rates would stay elevated for an extended period. The Commerce Department reported a 0.7% rise in retail sales in October, which was roughly double consensus expectations. The increase was particularly notable in online retail and the food service sector, indicating ongoing discretionary spending strength. Over the previous 12 months, retail sales rose by 3.8%, approximately in line with consumer inflation. In contrast, weekly jobless claims unexpectedly dropped below 200,000 for the first time since January.
However, data from the Commerce Department indicated continued weakness in the industrial sector, with overall industrial production increasing by 0.3% in September but remaining relatively stagnant over the preceding year, up by only 0.8%. The housing sector felt the impact of rising rates and a tight labour market. While September housing starts exceeded expectations, building permits, a forward-looking gauge, dropped by 4.4% during the month, marking the most substantial decline in 10 months.
The 10-year U.S. Treasury yield nearly touched 5% in intraday trading, reaching its highest level since July 2007. This surge in yields put pressure on the tax-exempt municipal bond market, with yields on AAA-rated municipal bonds rising and showing volatility. Simultaneously, primary issuance in the municipal bond market was heavy, which strained the secondary market. Demand for new deals, however, remained generally adequate.
Banks dominated new issuance throughout the week in the investment-grade corporate bond market, and spreads widened only slightly despite the heavy supply. In contrast, the high-yield bond market faced pressure due to escalating tensions in the Middle East. Weakness was evident across different ratings and sectors, with below-investment-grade funds reporting negative flows as risk aversion increased. On the other hand, the bank loan market appeared somewhat insulated from the broader risk-off sentiment, experiencing healthy demand for collateralised loan obligations and limited issuance.
Europe
Regarding local currency, the STOXX Europe 600 Index, representing pan-European stocks, closed the week 3.44% lower. This decline was driven by uncertainty regarding the trajectory of interest rates and concerns about the potential escalation of conflict in the Middle East. A series of disappointing earnings reports exacerbated the risk-off sentiment. Major Continental stock indexes also finished in negative territory. Italy’s FTSE MIB dropped by 3.12%, Germany’s DAX lost 2.56%, France’s CAC 40 Index fell by 2.67%, and the UK’s FTSE 100 Index declined by 2.60%.
European government bond yields experienced a general increase as investors contemplated the possibility of interest rates remaining elevated due to persistent inflation. Germany’s benchmark 10-year government bond yield increased, finishing the week just below 2.9%. Italian bond yields also rose, resulting in the yield spread between German and Italian 10-year debt expanding beyond 200 basis points. In the UK, the yield on the 10-year government bond rose following inflation data, which remained unchanged instead of decreasing.
European Central Bank (ECB) officials, including ECB President Christine Lagarde, Robert Holzmann of Austria, and Yannis Stournaras of Greece, emphasised the inflationary risk arising from the surge in oil prices caused by the Middle East conflict. Additionally, ECB Chief Economist Philip Lane mentioned to a Dutch newspaper that the central bank might need to wait until spring before it can be confident about inflation returning to the 2% target. Bundesbank President Joachim Nagel echoed Lane’s comments, expressing concerns about elevated price pressures in the eurozone and the persistence of upside risks.
In the UK, inflation unexpectedly remained at an annual rate of 6.7% in September, primarily due to rising gasoline prices. Services inflation accelerated to 6.9%. Data from a separate source revealed that wage growth, excluding bonuses, increased by 7.8% year over year during the three months ending in August, approaching a record high. Bank of England (BoE) Chief Economist Huw Pill stated before the data release that policymakers still have work to do to ensure that inflation returns to the 2% target.
German investor sentiment saw better-than-expected improvement in October, driven by expectations of declining inflation and stable short-term interest rates in the eurozone, as the ZEW Economic Institute reported. Meanwhile, business confidence deteriorated across various economic sectors in France in October, according to official statistics agency data.
Japan
Japanese stock markets experienced a decline during the week, with the Nikkei 225 Index slipping by 3.3% and the broader TOPIX Index down by 2.3%. This occurred against the backdrop of a mild reduction in inflationary pressures in Japan. However, attention was focused on wage growth due to indications of impending upward movements in pay demands for the upcoming year.
The most recent communication from the U.S. Federal Reserve suggested that interest rates would remain elevated for an extended period, leading to a surge in bond yields. The 10-year Japanese government bond yield reached 0.83%, marking its highest level in nearly a decade, up from 0.76% at the previous week’s close. The Bank of Japan (BoJ) adjusted its yield curve control policy in July, allowing yields to increase more freely while setting a cap at 1%. In a demonstration of the central bank’s preference for a gradual yield increase and avoidance of sharp fluctuations towards its ceiling, the BoJ took unscheduled action during the week, announcing a bond-purchase operation to slow the pace of yield growth.
The Japanese yen traded in the upper range of JPY 149 against the U.S. dollar, hovering near the critical JPY 150 threshold, which could trigger intervention by Japanese authorities to prevent the yen’s decline. The government reiterated its readiness to intervene in currency markets in the event of excessive exchange rate fluctuations. Failure to take action in the face of such extremes can negatively impact the real economy, affecting both ordinary citizens and businesses.
While Japan’s inflation rate decreased in September, with the core consumer price index rising by 2.8% year-on-year (down from 3.1% in August), price increases remained above the Bank of Japan’s 2% target for the 18th consecutive month. It is widely anticipated that the BoJ will revise its inflation forecasts upward at its October meeting.
The primary focus is on wage growth, particularly as higher pay demands for the upcoming year could signify evolving wage-setting behaviour and growing confidence in the BoJ’s progress towards its target. The Japanese Trade Union Confederation, known as Rengo, plans to push for a wage increase of at least 5% during the 2024 “shunto” labor-management negotiations between unions and companies. The BoJ sees sustained wage growth as crucial in achieving its inflation target.
China
Chinese stocks experienced a significant decline as deepening troubles in the property sector overshadowed the optimism stemming from a gross domestic product (GDP) report that surpassed expectations. The Shanghai Composite Index dropped by 3.4%, and the blue-chip CSI 300 surrendered 4.17%, wiping out all gains from the reopening rally earlier in the year. According to FactSet, the Hang Seng Index fell by 3.6% in Hong Kong.
Country Garden, formerly China’s largest property developer, announced its inability to meet all offshore debt payments after a 30-day grace period granted in August. The company’s missed dollar bond interest payment virtually assures its first-ever dollar bond default, underscoring the challenges facing China’s real estate market. Simultaneously, home price data indicated a persistent downturn in the property market. New home prices in 70 of China’s largest cities declined by 0.3% in September compared to August, extending the third consecutive monthly decrease.
Concerns about China’s property market outweighed a surprisingly robust GDP release, revealing that China’s economy expanded by 4.9% in the third quarter compared to a year earlier, surpassing forecasts but slowing from the 6.3% growth recorded in the second quarter. The economy expanded by 1.3% every quarter, an improvement over the 0.5% growth in the second quarter. Quarterly figures accurately reflect China’s underlying growth compared to year-over-year comparisons from a year ago, when major cities were under pandemic lockdown.
Other data suggested that certain segments of China’s economy might be stabilising. Retail sales increased by a better-than-expected 5.5% in September compared to the previous year, up from 4.6% in August. Industrial production growth remained steady compared to August, and urban unemployment slightly decreased.
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