Stocks and Bonds Enjoy Fading Inflation
So far this quarter, markets have hewed closely to their seasonal tendencies. While September and October are, historically, the two worst months for returns in the U.S. stock market, November is typically a very good month. This pattern has repeated in 2023. After peaking in late July, U.S. stocks turned lower through most of October, but then have enjoyed a sharp turnaround so far in November. The turning point for both the stock and bond markets in the quarter occurred in late October, amid favorable inflation data.
Interest Rates Drive Stocks, not Vice Versa
Unlike the short-term Fed Funds rate, which the Fed effectively controls, the 10-year U.S. Treasury note trades in the market, so its price and yield are set by supply and demand from investors around the world. In the U.S., long-term lending rates for the government, for companies and for individuals key off the yield on the 10-year Treasury, making it arguably the single most important data point in global finance. On October 23rd, the ongoing rout in the bond market over inflation fears pushed yields on 10-year Treasurys briefly above 5% for the first time in sixteen years. (As yields go up, bond prices go down.) Since then, however, 10-year yields have fallen back to 4.28%, a massive change in one month’s time. The likely reason for the decline in yields is that investors are finally gaining confidence that the Fed is getting inflation under control; the October Consumer Price Index (CPI) reading came in at 3.2%, down from 3.7% in September. Other components in the broad inflation calculation, such as owner’s equivalent rent, are also continuing to trend lower, boding well for continued easing in inflation. Stocks and bonds have both gained significant value since the October inflation figures were released, and many market participants expect the Fed’s interest rate policy to continue to slow the economy into 2024, eventually leading the Fed to reverse course and begin cutting rates next year.
Fed Awaiting Clearance for Soft Landing
The Federal Reserve’s goal is to reduce inflation to 2% without causing too much damage to the economy, and, ideally, to do so while not pushing the economy into recession. Recent data suggest that the Fed’s strategy is working, as inflation is on a gradual glidepath lower while the economy still seems to be in very good shape, bolstered by easing commodity prices, resilient consumers, and a strong labor market. This morning, the Commerce Department revised its estimate of third quarter gross domestic product growth for the third quarter up to 5.2%, faster than the initial 4.9% reading. (GDP measures all goods and services produced in a given period and is the broadest measure of the size of our economy.) An economy growing at 5% is still far from sinking into contraction.
Lower oil prices are also helping. Despite a significant cut in production from OPEC, oil now trades at only $77 per barrel of West Texas Intermediate Crude, down from over $90 in September. Gasoline prices, as of this writing, have dropped for sixty straight days, giving consumers a boost just as the holiday shopping season gets underway. With interest rates likely having peaked for this cycle and corporate profit growth likely having bottomed, 2024 is poised for a constructive start.
Geopolitical events of course have the potential to knock the bond and stock markets off their current favorable trajectory, but so far investors have stayed the course despite the new war between Israel and Hamas and the ongoing Russian invasion of Ukraine. Also, the fear of an imminent military takeover of Taiwan by China seems to have receded with President Xi Jinping’s visit to the U.S. earlier this month.
As always, we are closely monitoring developments in the markets and in geopolitics and are available to talk. Please get in touch if there are any financial matters you would like to discuss.
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