Fed's Williams tempers October hike fears

Good morning everyone and welcome to Julia's Bears Moving Markets Podcast. It is Wednesday the 30th of September and my name is Lucia Czciluvić, I am your host today. So on today's show I will first talk to my colleague Bernadette Andeako who will take us through the latest market developments and then I am happy to welcome Dario Messi to the show, our head of fixed income research, for an update on how markets are coping with higher yields. But first Bernadette, good morning, great to have you with us. Hey, good morning Lucia, great to be here. So let's start with the bond market where we have seen some rather dramatic moves. The 30-year Treasury bond yield crossed 5.6% on Tuesday reaching levels not seen since June 2002. Meanwhile the 10-year yield scaled to a fresh 2007 high near 5.3%. Yes, it has been quite the climb, Lucia and obviously we saw those yields on 30-year Treasury bonds rising for a 6th day. Investors are demanding greater compensation to hold these securities. I am looking forward to hearing what Dario has to say about this later on. And how did equity markets react to this searching bond yields? They weighed pretty heavily on risk appetite. The Dow declined more than 100 points yesterday, the S&P 500 and the NASDAQ slid 0.2% and 0.1% respectively. And it's worth noting that these moves came even as oil prices tumbled on the day. So Brent Crude was down 2.56% to $102.59 a barrel yesterday thanks to some positive supply headlines. Interestingly, US yields eventually steady across the curve. What can't the markets? New comments from the New York Federal Reserve President John Williams seem to have eased fears of higher central bank rates, or should I say at least for the moment. Williams said late yesterday and I quote, "There is no need for urgency and we have time to gather more information before the Fed's October meeting." So that dovish tone clearly resonated with traders. The CME Group's Fedwatch tool now shows that traders are pricing in a 49% chance of a quarter point rate hike next month. That's down significantly from 71% on Monday. Yeah, and today marks the last day of September and the third quarter, actually. So how have markets performed over these periods? It's been pretty mixed in both time frames. So for the month, the S&P 500 and Dow Jones are tracking for declines, while the NASDAQ is up more than 1%. But for the quarter, the S&P 500 and NASDAQ are both up 2%, while the Dow is off nearly 2%. So it's been quite a bumpy ride. I see. And moving to European markets, we saw a mixed week recession yesterday. The Pan-European Stux 600 closed 0.1% lower. What shaped the session? Well, two competing forces at play on the one hand, this surging global bond yields weighing on risk appetite and on the other AI-related optimism about a potential IPO providing a flaw for technology stocks. Among the major indices, the Cat Caron fell more than 0.5% Swiss SMI was down 0.2%. But the Euro stocks 50 gained 0.3% and the DAX managed 0.1% rise. Oil prices above $100 a barrel partly driven by the US Iran tensions, obviously also continued to fuel inflation concerns across the region. So you mentioned AI. There was an interesting development involving President Trump and tech executives. Can you tell us more? Yes, so President Trump announced yesterday that big tech executives have agreed to establish voluntary standards for artificial intelligence. He reiterated his support for the rapid expansion of data centers, even as concerns mount over AI safety and industries growing footprint in communities. But the meeting at the White House produced an agreement where companies will apparently work with independent auditors to assess whether AI systems are actually working as intended. And they also permitted to ensure that their tools don't hack or access technical systems in unintended ways. That's really interesting. Let's turn to Asia now. The dollar is heading for its best month since June and Asian stock markets are mostly higher this morning. What is catching your eye there? Well, Japan leading the pack the topics in the Nikkei definitely at the top of the leaderboard there this morning, MSCI's Asia Pacific index climbed 1% that's on course for its biggest advance in three weeks with 10 of the benchmarks 11 industry groups rising the only major exception was the Korean Cosby which was lower today. But the real good news came out of China overnight factory activity actually returned to growth in September as policymakers ramped up stimulus steps to bolster growth. That sounds quite significant. So what do the numbers tell us? Well, the official purchasing managers index rose to 50.1 from 49.8 in August. So that was in line with forecasts and it now sits just an expansionary territory. The Bureau of National Statistics said that the modest expansion was driven by accelerated activity in equipment and high tech related manufacturing as well as consumer industries. And the non manufacturing PM I also returned to expansionary territory climbing to 50.2 as business activity picked up in services and reached its highest level this year in construction. All right, and finally, Bernadette, what should investors be watching in the day ahead? Well, apart from geopolitical headlines, we've got a pretty busy calendar in the US. All eyes will be on the August reading of the personal consumption expenditures price index. That's obviously the Fed's preferred inflation gauge. Economists see the metric rising 0.3% for the month leading to an annual pace of 3.7%. We'll also get the third estimate of Q2 GDP and the ADP's report of private payrolls for September. Here in Europe, we've got September flash CPI prints for Germany, France and Italy, along with German unemployment data, and then from central banks. We're going to be hearing from four Fed speakers, as well as the ECB's Schnabel. And last but not least, the futures boards are actually pointing to a positive start to the trading sessions today. That's it from me, Lucia. Great. Very interesting. Thank you very much for this nice overview, Bernadette. Thanks for having me. Let's now turn to fixed income. Good morning, Dario. Hello, good morning, Lucia. So headlines about ever higher yields keep hitting the screens and still seem the main concern of investors. You are not concerned, right? Indeed. I mean, look, the reprising we went through again is certainly painful. That's clear when we heard from Bernadette, how investors just demand the higher yield now. And that's the result what we are seeing then on the screens. At the same time, I would really stress where the increasing yields is coming from. I think that's very important. And it is primarily driven by higher real yields, not for certainly to a less extent by rising inflation expectations. Or any kind of declining confidence in central bank's ability. And more in this case here, mostly the fat ability also to control inflation. These are some narratives that are still creating out there, but we don't really see kind of clear evidence for such developments. And I think that's key. Also, the flatter yield curve, at least compared to some month ago supports the view that this is not about any kind of risk premium or fat credibility. So yes, higher yields have cost losses for bond investors, but the current environment keeps offering interesting entry points for intermediate maturity. And we really think they offer attractive diversification and also income potential here. All right, and if you are listeners, would like to hear more on this topic, be sure to tune in to the view beyond podcast, which will be released this Saturday, that it takes a deeper dive into the subject there. But for now, let's turn back to today's show and shift our focus to corporate credit. How have credit markets coped with the recent rising yield study? Yeah, I would say on aggregate. If you just look at the headline numbers, it's actually quite good. We we discussed it very often also in this show here how the starting position for corporate balance sheets is quite favorable. And also when you look at growth, you discussed it before still quite resilient readings that we are seeing, and especially if you think about all the shocks that we are going through. And this just naturally keeps default rates down. At the same time, what we also see is, and specifically also more pronounced now in September is some despair, this version that is happening underneath. And in fact, that's exactly what we also expected. So solid balance sheets, coupled with strong earnings, helped to dampen the impact from higher rates so far. But of course, there are also leverage structures out there. And for them, it's much more difficult to digest a higher for longer rate world. And this is something we are really seeing in the performance as well by now. So this person accelerated and the weakest balance sheets are suffering. And we don't expect this to change here. For that reason also, it's why we would really keep this quality bias when constructing credit portfolios. Having said this, in case we see some further spread widening, as we are seeing now, at the weaker balance sheets, all else equal, we might become more opportunistic in the next couple of months. That's very interesting. Thanks a lot for being with us this morning, Dario. Thank you for inviting me. As always, a pleasure. So that is all for today then thanks again to my guests and thank you all for tuning in. Please join us again tomorrow when we will be back with more news moving the markets. Have a great day everyone and bye for now. The information and opinions expressed in this podcast constitute marketing material and are not the result of independent financial or investment research. Please refer to www.dueliusbear.com/legal/podcast for further other important legal information.