No more bullish bets on WTI and the US may have to increase IRs

Claire Linh Nguyen
Oct 25, 2024
7 min read

What do we need to know for the week ended on 18th Oct 24

💡Highlights 💡

Hedge Funds Cut Bullish Bets on WTI Crude to Eight-Month Low as oil had its first weekly decline this month.
ECB cut rates by 25 basis points, while the US may raise interest rates in the upcoming months.
China’s stimulus announcement triggered a rally in the equity market as investors welcomed the government's efforts to support economic growth.
The UK’s Autumn budget plan may lead to increased government borrowing, which could push up yields on UK government bonds (gilts) as investors demand higher returns to absorb the additional debt supply.

US Market Insights

This week, the U.S. stock market continued its strong upward trend, with the S&P 500 securing its sixth consecutive week of gains. Investor confidence was buoyed by encouraging economic indicators, particularly a robust retail sales report and resilient consumer spending, which collectively eased recession fears and fueled optimism about the economy’s resilience. Retail sales in September rose by 0.4%, outperforming expectations, while core retail sales, excluding autos and gas, surged by 0.7%. This steady consumer activity has bolstered equities, underscoring the economy’s momentum even as higher interest rates linger.

In light of the solid data, investors have tempered their expectations for significant near-term interest rate cuts. Although the Federal Reserve cut rates by 50 basis points in September, strong retail sales and lower-than-expected jobless claims suggest the Fed may adopt a more measured approach to future rate reductions. The 10-year U.S. Treasury yield remained elevated at around 4.1%, reflecting the likelihood of a gradual rate-cutting approach as economic fundamentals remain sound. Bond yields’ steadiness, alongside tightening credit spreads, reflects a healthier risk sentiment among debt traders, suggesting investor confidence in corporate and financial stability.

Banking Sector Gains and Investment Considerations

The banking sector saw notable gains, as reduced regulatory concerns under a potential Trump presidency attracted investor interest in financial stocks. The SPDR S&P Regional Banking ETF climbed 5.9% this month, highlighting strong performance within financials, which have emerged as top-performers in the S&P 500. The tightening of credit spreads, indicating a shrinking gap between corporate bond yields and government bond yields, signals improved confidence in corporate financial health, benefitting banks with high exposure to credit markets.

In this environment, investors may find bank stocks a strategic addition to their portfolios. With credit spreads tightening and credit markets displaying optimism, banks are well-positioned to benefit from a stable economic outlook and declining default risk. Furthermore, higher interest rates offer banks opportunities for wider net interest margins and enhanced profitability through lending activities. Following a strong third-quarter earnings season, the sector is likely to continue to perform well, making bank stocks an attractive investment through the end of 2024.

UK Market Insights

The UK market saw varied results across sectors as major developments in inflation, fixed income, and equity markets impacted investor sentiment. Falling inflation and the approaching Autumn Budget have increased expectations of interest rate cuts by the Bank of England (BoE), even as concerns grow around heightened government borrowing through expanded bond issuance. The recent dip in inflation supports a more accommodative monetary policy stance, as the BoE aims to encourage economic stability amidst signs of a slowdown. Though rate cuts could ease pressures on consumers and businesses, their timing and scope remain dependent on further economic data.

Reflecting the market’s expectations of BoE rate reductions, the yield on the UK 10-year gilt fell to 4.09% this week. Nonetheless, the impending Autumn Budget could introduce upward pressure on gilt yields, with Chancellor Rachel Reeves expected to propose a fiscal plan combining tax increases and spending restraint to shore up the UK’s finances. This £40 billion ($52 billion) initiative could lead to increased government borrowing, potentially requiring higher yields to attract investors to absorb the additional debt supply. As the market balances potential BoE rate cuts with this fiscal strategy, volatility may emerge depending on the clarity and reception of the government’s long-term approach to debt management.

Investment Considerations in a Volatile Market

In the current environment, investing in Credit Default Swaps (CDS) offers investors a strategic hedge against rising credit risks in the UK while allowing them to potentially benefit if credit conditions worsen. With tightening credit spreads indicating lower perceived risk in the corporate debt market, CDS premiums are relatively inexpensive, providing an opportunity to secure protection at a lower cost. This insurance-like investment acts as a safeguard against borrower defaults, whether corporate or government, which is particularly relevant in the uncertain UK market.

With concerns around the Autumn Budget and potential fiscal tightening, CDS investments offer a defensive strategy for those holding UK corporate or government bonds, providing a buffer in case of a rise in defaults or increased credit stress.

EU Market Insights

The European Central Bank's (ECB) third interest-rate cut this year has bolstered investor confidence that additional easing measures may soon follow. Though ECB President Christine Lagarde adopted a cautious tone, her comments left the door open for more aggressive monetary moves. This aligns with the ECB's ongoing goal of nudging inflation closer to its 2% target. Analysts widely expect a further rate cut on December 12, driven by softening inflation indicators and an increasingly challenging economic outlook in some parts of the Eurozone. Market sentiment suggests the ECB is leaning toward further cuts to support struggling industries.

In response, European markets showed a mix of optimism and caution this week. The STOXX 600 rose 0.55%, buoyed by anticipation of continued ECB support, while the DAX held near record highs. Rate-sensitive sectors like real estate and consumer discretionary stocks led gains, as investors expect these sectors to benefit from lower borrowing costs and heightened consumer demand under an accommodative monetary policy.

In fixed income markets, this evolving outlook was reflected in bond movements, with Germany's 10-year Bund yield falling to 2.22%. This drop signals heightened expectations for another rate cut at the ECB's December meeting. Bond markets have rallied in anticipation, with traders pricing in at least one more 25-basis-point cut before year-end and possibly a 50-basis-point reduction in 2024 if economic conditions necessitate further action.

Investment Strategy Considerations

Looking ahead, EU equity markets appear primed for growth, especially with the likelihood of further rate cuts in December. Bullish investors may find an opportunity by taking long positions in EU equities, with a potential exit target in Q1 2025. Increased exposure to rate-sensitive sectors, such as real estate, consumer discretionary, and technology stocks, may prove advantageous. These sectors generally benefit from lower interest rates due to improved borrowing conditions and strengthened consumer spending, positioning them well for potential gains as the ECB continues its easing trajectory.

Asian Market Insights

China

China’s stock market rebounded this week after Beijing pledged additional fiscal support to counter recent economic sluggishness, providing a much-needed lift following its worst week since late July. The market rally reflects renewed investor confidence in the government’s commitment to spurring economic growth. China’s GDP grew by 4.6% year-on-year (YoY) in Q3 2024, narrowly missing the previous quarter’s 4.7% growth rate and falling short of the government's 5% full-year target.

September's economic data offered a temporary boost to sentiment, showing improved consumer spending and industrial output. Retail sales jumped by 3.2% YoY, up from August’s 2.1%, while industrial production rose to 5.4%, an increase from 4.5% the previous month. Meanwhile, the unemployment rate fell to 5.1%, its lowest since June, reflecting the positive effects of government subsidies on consumer goods. Specifically, home appliance sales surged by 21%, and auto sales rebounded, ending a six-month slump.

Despite these gains, China’s economic outlook remains clouded by persistent structural issues in the property sector, which has historically driven a significant portion of its growth. Property prices in 70 major cities dropped by 5.7% YoY in September, marking the 15th straight monthly decline and the sharpest since May 2015. This prolonged downturn in the real estate market, once accounting for nearly a quarter of China’s economic activity, poses a continued threat to economic stability. Investors are hopeful, but the impact of these structural issues highlights the ongoing risks and challenges in China’s economic landscape.

Japan

Japan’s economic outlook encountered new challenges this week, highlighted by the largest drop in exports since February 2021, as global demand softened. This setback is particularly significant for Japan, where economic recovery has been fueled by robust export growth to major trade partners. The downturn in exports adds complexity to the Bank of Japan’s (BoJ) policy outlook, especially as domestic inflation trends downward.

Inflation in Japan cooled more than anticipated in September, with headline inflation dropping to 2.5% and core inflation (excluding food and energy) easing to 2.4%. These figures, though slightly above expectations, indicate a reduction in inflationary pressure, which may influence the BoJ’s cautious stance on policy adjustments. Meanwhile, the yen neared the 150-per-dollar threshold, sparking concerns about potential intervention to stabilize the currency.

In fixed income, the yield on the 10-year Japanese government bond rose to 0.98%, its highest in 11 weeks. This reflects market expectations that the BoJ will likely hold its policy steady, with limited rate cuts. BoJ board member Seiji Adachi emphasized a “very moderate” approach to future rate hikes, underscoring the need to avoid sudden changes given the global economic uncertainties.

Investment Considerations

Amid this environment, investors might look at long positions in the Japanese yen, holding until Q1 2025. With potential rate cuts anticipated from the US and European central banks, alongside Japan’s cautious rate hike approach, the yen could strengthen as global interest rates decline. This strategy leverages the yen’s tendency to appreciate in lower rate environments, offering investors a chance to capitalize on expected monetary easing globally.

Source: CNBC, Bloomberg, FTnews and Reuters.

Market indicator - 18th Oct 24

Disclaimer

The content on this website is for general informational purposes only and does not constitute financial advice. No liability is accepted for any loss or damage arising from reliance on the information provided.