Earnings Optimism Lifts Markets

MACRO FRAME

September’s CPI and PPI data continue to fuel expectations of a new hiking cycle from the Fed, while higher interest rates are adding to stress in credit markets.

STOCK INDEX FUTURES

Equity index futures were higher overnight as earnings optimism triggered a broad-based risk-on sentiment. SpaceX’s results on Tuesday have for the time being renewed for the enthusiasm for the AI trade ahead of Tesla and Meta earnings after the close. Concerns about debt financing have given way to renewed optimism about AI-related growth, putting the technology earnings outlook back at the center of market sentiment. Despite the latest rebound, the SOX semiconductor index’s recent reversal remains notable. The index is still up almost 60% year to date but is testing a level it has touched twice before over the past three months. Semiconductor weakness have coincided with renewed strength in consumer staples, suggesting investors had been positioning away from tech leaders toward defensive sectors ahead of earnings season, raising questions about the level of confidence in optimistic earnings expectations. Approaching midterm elections present a potential market risk, but politics so far does not clearly explain the recent reversal. Prediction markets have placed the probability of Democratic control of the Senate slightly above 60% for several weeks, suggesting little recent change in that particular risk.

CURRENCIES

US DOLLAR: The USD index is little changed at 101.66. The dollar has come under pressure as Treasury yields have fallen, despite its safe haven appeal. Investors have sought the safety of US Treasuries amid the volatility in AI stocks ahead of major earnings, suggesting that equity sentiment and perceptions on the growth outlook for the AI space have an important bearing on the dollar. However, today’s rise in stocks and drop in yields presents a market shift that suggests optimism instead of caution. Money markets continue to assign a 15% probability of a hike this month and remained fully priced in for a hike by year-end. On Friday, Fed Chair Kevin Warsh declined to indicate the likely outcome of this month’s Fed meeting but noted that stronger-than-expected inflation had not changed his assessment of the US economy.

Watch point: While current fiscal, macro, and geopolitical factors favor the dollar, it is beginning to enter overbought territory and could be susceptible to a modest correction.

EURO: The euro fell 0.08% to $1.1227. The main headwind for the euro remains French bond-market stress, which highlights the tension of protesters demanding more spending and bond markets demanding fiscal restraint, creating a potential drag on confidence in the currency. Moody’s upcoming sovereign-rating review represents an additional sentiment risk. Its French rating is currently two notches above those of S&P and Fitch. This also leaves the lower house’s budget vote to remain in the spotlight. As for the ECB, money markets continue to expect no policy action this month, while pricing an 88% chance of a hike in December. The market is also priced for 71 bps of tightening over the next 12 months.

Watch point: French sovereign stress will continue to be a dominant factor in price direction, however, the $1.10 level acts as a strong resistance level.

BRITISH POUND: Sterling is 0.13% higher against the dollar at $1.3393. Sterling continues to outperform; stronger-than-expected inflation data overnight follows Tuesday’s solid labor-market data, which have reinforced expectations of a November hike from the Bank of England. Headline CPI inflation rose to 3.5% from 3.1% in August, above the 3.4% Reuters consensus. Services and core inflation also exceeded expectations, strengthening the case for further tightening following Tuesday’s firmer wage and labor-market figures. Tuesday’s data also showed that annual weekly earnings growth excluding bonuses rose to 3.7%, versus an upwardly revised 3.6% in the three months through July, while unemployment fell to 4.7%. Taken together, the figures suggest labor market conditions alone may not be enough to bring inflation under control. However, while the reports make the case for a November move the reality of an aggressive sequence thereafter appears unlikely.

JAPANESE YEN: The yen rose 0.15% to 157.93 yen per dollar. Bank of Japan Deputy Governor Ryozo Himino said underlying inflation was close to the BOJ’s 2% target, while also describing financial conditions as loose, signaling that there could be some scope for further tightening. Markets remain priced for 18 bps of tightening be year-end, while expecting a hike to come in January. Over the next 12 months the market is priced for 72 bps of tightening. The currency remains under broad pressure from US rate differentials and a market that is unconvinced the central bank will raise rates in a timely manner. The greatest near-term upside risk for the currency remains market intervention.

Watch point: While markets are underwhelmed at the BOJ, a path for additional rate hikes looks to be  appears to be the primary scenario.

AUSTRALIAN DOLLAR: The Aussie rose 0.44% to $0.7034. Reserve Bank of Australia Deputy Governor Hauser overnight said that the effects of tighter monetary policy were becoming evident, though the inflation outlook was “materially worse,” thanks to high oil prices. Following his comments, money markets increased expectations of a November hike from 30% to 57%. However, these expectations could be overdone, especially following recent labor data, which showed a drop in employment, which could give the RBA some confidence that policy settings are adequately restrictive.

Watch point: August’s hiring figures argue for a higher-for-longer stance, leading the focus to Q3’s inflation data.

TREASURY FUTURES

Yields moved lower across the curve. The market looks to be pulling back as it had priced in substantial tightening ahead of central banks that are unlikely to move rapidly. Paired with the recent volatility in AI and attractiveness of a solid return the market was left vulnerable to a decline in yields. Still, firm growth, elevated inflation, and expectations of further global central-bank tightening remain the broader forces that will continue to move yields higher over the longer-term. Today will see a $13 billion auction in 20-year Treasury bonds. The two-year/10-year spread is approximately 32.00 bps, down 29 bps from its October high of 51.40 bps, reflecting that front-end rates remain tied to central bank expectations while long-end rates saw strong buying. Treasuries have found defensive appeal as investors reassess the debt surrounding the AI buildout, the main signal being the rally in Treasuries despite the hot CPI and PPI prints last week and the Fed’s October Beige Book revealing intensifying input-price pressure, including higher oil and diesel costs moving through freight and supply chains. While the hawkish Fed has led the curve to flatten amid contained inflation expectations, we continue to see upside risk to long-term borrowing costs if growth remains resilient.

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