Markets hate uncertainty and thrive on clarity. A better sense of the path forward may offer more runway to rally.
Sweet relief. The S&P 500 u-turned from its recent selloff and clocked its best week of 2023. Bond yields, especially on the longer end, have fallen dramatically. That propelled government bonds around the world to one of their best weeks of the year. Both 10-year and 30-year U.S. Treasury yields have fallen about 40 basis points (bps) from their highs just a few weeks ago. Even U.S. high yield bonds showed up to the rally, with spreads tightening last week by the most since March.
So as we barrel toward the end of the year, are markets finally finding direction?
Last week was jampacked with big-picture catalysts—from a flurry of central bank meetings to a handful of economic data prints, to a new sense of the U.S. government debt situation—and each seems to have brought a clearer sense of the path forward.
Here is what we learned, and why we think it brings more comfort for investors:
1) Pretty much every major central bank has said they’re done hiking (just without actually saying they’re done hiking).
The Federal Reserve, European Central Bank and Bank of England all kept policy rates unchanged at their latest meetings. Only the Bank of Japan is left holding on to an easier policy stance, and still, it’s slowly shifting toward tightening.
The chart is a line graph of the historical and implied policy rates across 4 central banks: the Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan. The US Policy rate starts at 0.25% on December 31, 2014 and trends upward to 2.5% on December 31, 2018. The first data point for all three starts in December 2015 where the Fed’s policy rate was 0.25%, the BoE’s policy rate was 0.5%, the ECB’s policy rate was -0.2%, and the BoJ’s policy rate was 0.1%. In February of 2016, the BoJ lowered its policy rate to -0.1%, the ECB lowered its rate to -0.4 while there was no change to the Fed (0.5%) and BoE (0.5%) policy rates. In August of 2016, the BoE lowered its policy rate to 0.25% while there was no change to the Fed (0.5%), ECB (-0.4%) and BoJ (-0.1) policy rates. From December 2016 to December 2018, the Fed began raising interest rates, eventually reaching a level of 2.5%. During the same time period , the BoE raised and held rates at a level of 0.75%. Since cutting rates in 2016, the ECB left policy rates unchanged at -0.4% and the BoJ has left their policy rate unchanged at -0.1% all the way until present day (October 30th, 2023). In July 2019, the Fed began cutting rates from 2.5% before eventually stopping at a level of 0.25% in March of 2020. The BoE also cut their policy rate in March of 2020 to a level of 0.1%, while the BoJ and ECB left their policy unchanged during this time at -0.1% and -0.4% respectively. In December of 2021, BoE began rapidly increasing rates reaching 3% in November 2022, to their current level of 5.25% as of October 30th, 2023. The Fed began rapidly raising its policy rate slightly after the BoE in March of 2022, reaching 3.25% in September 2023, and eventually touching a level of 5.5% as of October 30th, 2023. Starting in June 2022 the ECB hiked its policy rate to 4.0% by October 2023. During both time periods the BoJ has kept their policy rate unchanged at a level of -0.1%. Implied future rate for the Fed lands at 4.8% by November 2024, 4.9% by September 2024 for the BOE, 3.2% for the ECB by October 2024, and 0.2% by September 2024 for the BOJ.
After months of questioning when the end would come, and even one “skip” meeting followed by a hike thereafter, conviction that the Fed is actually done with hikes is growing. Markets are pricing in just a ~15% chance of one more hike. If it comes at all, investors are betting on it happening in January. By then, policymakers should have an even clearer read on the economy, and this month’s data has pointed to more cooling.
Why does it matter? When the Fed has officially hiked its last time in the past, that’s tended to provide runway for markets to rally. In the last seven Fed hiking cycles, U.S. stocks and investment grade bonds meaningfully outperformed cash—by 19% and 14%, respectively—over the following two years.
2) The economy is slowing a bit, and that’s not a bad thing.
So far, inflation has cooled without much economic pain in the U.S. As we noted last week, Q3’s U.S. GDP print was a case in point for how resilient growth has been.
But from here, growth probably needs to slow down a little (just as it has done in Europe) to ensure that inflation doesn’t reaccelerate (and prompt more moves from central banks). Last week, from manufacturing and services reads to labor market data (see the cooldown in hiring in Friday’s jobs report), signs have pointed to some fading momentum. CEOs have echoed the same this earnings season, with more notes of dampening demand and shifts in spending patterns (even as the overall trend is still a solid one).
In more good news for a potential soft landing, word also came that the economy might be getting more “productive”. In other words, it’s using all the resources it has—from all its workers and its capital to its technological investments—more efficiently than it used to. The latest read on U.S. productivity, measured by how much employees are producing per hour, advanced by the most in three years. Meanwhile, unit labor costs, or how much a business pays its workers to produce one unit of whatever it’s producing, fell last quarter—its first decline since 2022. Taken together, this means inflation may be able to keep cooling while the economy avoids a meaningful contraction.
3) The U.S. Treasury plans to borrow less than expected next quarter.
Bond yields surged over the summer in part as the Treasury said it was going to have to issue more debt to help fund the government’s spending. All else equal, more Treasury supply puts downward pressure on prices and upward pressure on yields.
Fast forward to today. In its latest update last week, the Treasury said it plans to borrow less than it anticipated in Q4, and it also intends to issue less longer-dated bonds than expected to get its job done. That shift may make it easier for the market to digest the added supply.
While we still need to see how buyers will take on this latest round of supply, last week’s news signals that bond markets might be faced with less volatility ahead.
Markets hate uncertainty, and they thrive on clarity.
In all, a better sense of the path forward offers more runway to rally.
It’s a bond buyer’s market with interest rates at today’s levels. One of the most popular measures of the U.S. Treasury yield curve (the difference between 2-year and 10-year bond yields) has moved from about 100 bps of inversion in July to about 30 bps today. That has had similar knock-on effects in European and UK bond markets, too. For investors, this means that you don’t need to give up nearly as much yield to extend duration. Across the maturities, currencies (USD, EUR and GBP), risk spectrums and issuer types, investors have the opportunity to buy bonds at yields we haven’t seen in 15 years. To echo our earlier point and add potential urgency, yields have a habit of falling (and prices rising) after the Fed is done raising interest rates.
The chart shows the 10-year Treasury yield since the start of 2023. The yield starts at 3.87% on January 2, 2023. The yield trends downward to 3.37% on January 18, 2023. Then the yield trends upward to 4.06% on March 2, 2023. Then the yield trends downward to 3.31% on April 6, 2023. Then the yield trends upward to 4.03% on July 6, 2023. The yield continues to trend upward to 4.99% on October 19, 2023. The yield finishes at 4.68% on November 2, 2023. The labels and associated dates and yields (taken from the day prior to the event) are: February FOMC Meeting: Feb 1st, 3.42% U.S. regional banking crisis: Mar 8th, 3.96% May FOMC meeting kickstarts “higher for longer” speculation: May 3rd, 3.57% Bank of Japan loosens its yield curve control policy: Jul 28th, 3.87% Fitch downgrades U.S. government credit rating: Aug 1st, 3.96% U.S. Treasury ramps up issuance: Aug 2nd, 4.02% September FOMC meeting: Sep 20th, 4.36% Israel-Hamas conflict: Oct 6th, 4.72% November FOMC meeting and Treasury refunding announcement: Nov 1st, 4.83%
We think now offers an entry point for U.S. stocks. Even after last week’s rally, stocks are still pricing in a lot of bad stuff. Roughly 70% of S&P 500 stocks are in correction territory (or down 10% or more from their 52-week highs), and broadly, valuations are about back in line with long-term averages. Seasonality could also prove favorable: going back to 1950, November and December are usually two of the best months of the year. Finally, with more stability in bond yields, investors can soon refocus on fundamentals. Earnings are having a transition quarter, and expectations from here point to future growth. That’s especially true for tech+, where improving earnings and the power of AI combine to create a compelling case.
In Q1 2019 earnings growth was 0.2% In Q2 2019 earnings growth was 1.2% In Q3 2019 earnings growth was -1.6% In Q4 2019 earnings growth was 1.0% In Q1 2020 earnings growth was -14.1% In Q2 2020 earnings growth was -32.2% In Q3 2020 earnings growth was -6.7% In Q4 2020 earnings growth was 1.2% In Q1 2021 earnings growth was 4.7% In Q2 2021 earnings growth was 86.9 In Q3 2021 earnings growth was 36.7 In Q4 2021 earnings growth was 30.9% In Q1 2022 earnings growth was 10.3% In Q2 2022 earnings growth was 7.4% In Q3 2022 earnings growth was 3.3% In Q4 2022 earnings growth was -3.4% In Q1 2023 earnings growth was -1.4% In Q2 2023 earnings growth was -3.8% For Q3 2023 expected earnings growth is 3.7% For Q4 2023 expected earnings growth is 3.9% For Q1 2024 expected earnings growth is 7.2% For Q2 2024 expected earnings growth is 10.8% For Q3 2024 expected earnings growth is 10.1% For Q4 2024 expected earnings growth is 16.4%
Finally, if we’re wrong, alternatives can be a powerful force in portfolios. Real assets can offer protection if inflation lingers (or, in a worst case, reaccelerates). Private credit can benefit in an environment with higher interest rates and tighter financial conditions. And experienced managers can capitalize on stress in commercial real estate.
In all, we see opportunity in a world in transition.
Your J.P. Morgan team is here to discuss what it means for you, and the opportunities we see ahead.
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