November was nothing short of Christmas for investors who have been waiting for constructive price action. North American equity and fixed income markets both gained after the ‘Higher for Longer’ narrative in the markets was lessened by expectations of the Central banks policy rate hikes being done for this cycle, reversing the draw down of the past three months. Market participants brought forward the expectations of the first rate cut by the US Federal Reserve from June 2024 to March 2024 (See Figure 1). Incoming economic data pointing towards a softening economy put together with a benign inflation picture ignited market enthusiasm. This is even though the US Federal Reserve chairman, Jerome Powell, said that he is not confident if the policy rates are restrictive enough to bring inflation rate back to 2%.
Figure 1: Earlier Policy rate cut expectations have increased.
Statistics Canada reported that headline inflation in Canada dropped to +3.1% (expected +3.14%) in October (reported in November) from +3.8% during the previous month. As per the Bureau of Labor Statistics, headline inflation in the United States fell to +3.2% (expected +3.31%) during October (reported in November) from +3.7% in the previous month. Tight labor markets, which have been a cause for concern for the Central Banks due to their capacity to fuel inflation for longer, have also showed signs of relaxing on both sides of the border. The unemployment rate in Canada advanced to +5.7% (expected +5.61%) in October (reported in November) from +5.5% in the previous month. More recent reports suggest unemployment further increased to +5.80% in Canada. The unemployment rate in the United States advanced to +3.9% (expected +3.79%) in October from +3.8% in the previous month. The constant flow of supportive economic data intensified the expectations of a rate cut sooner than expected and led to a swift decline in bond yields across the yield curve (see Figure 2 and 3).
Figure 2: US Yield Curve – 31 October 2023 to 30 November 2023
Figure 3: Canada Yield Curve – 31 October 2023 to 30 November 2023
We like to highlight that price action in the fixed-income markets once again seems to be at odds with the message from the United States Federal Reserve Chairman, who has maintained that more evidence is required before concluding that inflation is on a trajectory to be back to their target of +2.0%. Given this backdrop, we think the current set-up is ripe for more volatility as markets once again seem to be defying the message from the Central Banks. As the adage goes – “Never Fight the Fed”.
That said, we think the overall outlook for risk assets remains favourable despite the expected volatility. Our optimism stems from inflation continuing to go in the right direction and our expectations of more favourable readings in the coming months as the ‘Shelter’ component of inflation calculations continues to roll over. The labour market has begun to soften and in absence of any major uptick in unemployment, the expectations of a ‘soft landing’ could continue to outweigh the conversation on ‘hard landing’. Lastly, valuation of most companies has continued to reflect caution for the most part of the year, suggesting a large part of the markets might not be trading ahead of fundamental realities.
We wish our readers a Merry Christmas and a very Happy Holiday Season.