Market Brief: Ebullience Returns

A sense of optimism is powering financial markets forward this morning, with China promising more economic stimulus, a raft of Federal Reserve speakers likely to deliver relatively-dovish messages in the hours to come, and reports suggesting that Saudi Arabia is preparing to increase oil production. Treasuries are flat, equity futures are pointing higher ahead of the North American open, and the dollar is retreating against its major counterparts, with the euro, pound, and Canadian dollar all eking out half-percentage point gains relative to yesterday's close.

In a highly unusual September announcement, the Chinese politburo said it would mobilise “necessary fiscal spending” to support property prices and lift economic growth, adding fuel to the central bank’s stimulus efforts earlier in the week. According to the Xinhua news agency - the official mouthpiece for the Communist Party - "new situations and problems" justify taking more extreme measures to "promote the stabilisation of the real estate market,” with policymakers pledging to “respond to people's concerns, adjust home purchase restriction policies, lower existing mortgage rates and improve land, fiscal, tax and financial policies as soon as possible to push forward the new model of property development”. A separate statement said that the government would distribute a one-time cash payment to poor and disadvantaged people ahead of next week’s holiday, and earlier in the week, People’s Bank of China Governor Pan Gongsheng said the central bank would implement "forceful" interest rate cuts, lower reserve requirements, and deploy a series of lending facilities designed to support stock purchases.

We’re inclined to fade the impact on global markets. As outlined in previous missives, the likelihood of a return to China’s post-2008 growth model looks very low, meaning that a less commodity-intensive and more services-driven recovery beckons ahead. And - although the numbers used below date back to 2018 - China’s trade relationships with the world still vastly exceed its financial linkages. Simply put, on a net basis, China subtracts consumer demand from the global economy, and adds financial capital.

A deluge of Fedspeak will hit markets through the trading session. Chair Jerome Powell will deliver pre-recorded opening markets at the US Treasury Market Conference around 9:15 this morning, with New York’s John Williams, Boston’s Susan Collins, Governor Adrianna Kugler, Governor Bowman, and Minneapolis’ Neel Kashkari, and Vice Chair Michael Barr all scheduled to make appearances at other events during the day. We expect a continued emphasis on downside risks in labour markets - particularly after Tuesday’s disappointing Conference Board print - and think that officials will only heighten the drama going into next week’s non-farm payrolls report. If the unemployment rate rose and the US economy failed to generate more than 140,000 jobs in September, markets will move to raise the odds on a second, half-percentage-point move at the Fed’s November meeting.

The Swiss franc is trading on a stronger footing after the Swiss National Bank cut interest rates by 25 basis points, disappointing some market participants who were expecting a bigger move. “With today’s easing of monetary policy, we are taking the reduction in inflation pressures into account,” said President Thomas Jordan, “Further cuts in the (Swiss National Bank) policy rate may become necessary in the coming quarters to ensure price stability over the medium term”. The central bank has now eased policy at three consecutive meetings, and is seen delivering a total of two more cuts over the next three quarters, bringing the policy rate down to 0.5 percent or lower.

Global oil benchmarks are down after an article in the Financial Times said “Saudi Arabia is ready to abandon its unofficial price target of $100 a barrel for crude as it prepares to increase output, in a sign that the kingdom is resigned to a period of lower prices”. According to the piece, the Saudis are unwilling to continue ceding market share to other oil producers, and intend to begin unwinding voluntary output cuts in December.

We’re not sure Saudi Arabia really had a $100 target, but prices have come under sustained pressure this year against a deteriorating demand backdrop and a high level of spare capacity among cartel members. The country’s fiscal deficit has widened even as evidence of an offsetting negative supply response from non-OPEC producers has been difficult to see.

The United States’ reemergence as a global energy superpower has changed how currency markets react to fluctuations in crude prices. The shale oil revolution - the massive boom in unconventional oil production that began in the late aughts - has turned the US into a net oil exporter, substantially reducing economic vulnerabilities to rising prices. The country’s commodity terms of trade - the ratio of the average price of raw material exports to the average price of imports - exhibited a negative relationship with oil prices from the 1960’s through to the early 2010’s, but now tends to improve when prices rise. The dollar is now somewhat insulated against price shocks - in both directions - and no longer plays the foil to oil exporter currencies like the Canadian dollar.

The Mexican peso is trading with a modestly firmer bias after taking a series of blows during yesterday’s session. Emerging market currencies generally found themselves on the firing line early on Wednesday as the Chinese stimulus rally fell apart, Tropical Storm John threatened to inflict more damage on the Pacific coast, and Bloomberg reported that an analyst with Moody’s warned of possible damage to the country’s credit rating if outgoing president Andrés Manuel López Obrador’s judicial overhaul impacts investor sentiment.

Mexico’s central bank will almost certainly deliver a rate cut later today, but isn’t likely to act as aggressively as its US counterpart. A half-percentage-point move is certainly a possibility: growth appears to be decelerating in line with the Banxico’s forecasts, labour market conditions are softening, and core inflation fell to 3.95 percent year over year in the first two weeks of September - marking its weakest pace since February 2021. We think, however, that with the impact of this summer’s depreciation in the peso yet to filter through into prices, constitutional reform uncertainties threatening to slow the flow of inward investment, and the approaching US election poised to raise background volatility, policymakers will opt to tread cautiously for now.

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