Macroeconomic Overview for October 2024

Eugeniu Kireu, CFA

Nov 20, 2024

In October, the stock market dynamics were determined more by political than economic factors. The debt markets reversed after the Fed's 50 basis point rate cut in mid-September. In October, their correction only accelerated. This was facilitated by two key factors. The first is the shift from overly optimistic expectations regarding rate cuts and inflation, which did not match macroeconomic statistics. The second and even more important factor is the increased likelihood of Trump's victory. In investors' perception, a Trump victory and Republican control in Congress are associated with greater risks for inflation growth than a Harris victory. However, the exact impact of these measures is difficult to assess at this time, as is the form in which they will be implemented.

In October, the index of global high-quality bonds decreased by 3.4%, high-yield global bonds lost 0.63% in value, and emerging market bonds fell by 1.4%. High-quality US bonds fell by 2.5%, and high-yield bonds by 0.54%. The developed countries' stock index dropped by 2.0%, particularly the S&P 500 by 0.92%. The seven largest companies in the S&P 500 index lost an average of 0.41%, while the others fell by 1.4%. Emerging market stocks fell by 4.3%, and Chinese company stocks (MSCI China index) by 5.9%. Expected stock volatility for the next month increased to 21.4 due to growing uncertainty ahead of the elections.

Trump's victory deepened investors' uncertainty about future inflation and fiscal policy. At the same time, economists' forecasts do not indicate that price growth will be very high. Bloomberg analysts believe that if the most likely part of the initiatives is implemented, inflation will rise by 0.2 percentage points over the next three years. If all measures are implemented, inflation will increase by 0.4 percentage points. At the same time, since the reversal in September, the yield on ten-year US Treasury bonds has increased by 0.8 percentage points, and inflation expectations for the same 10 years ahead have increased by 0.4 percentage points. It seems that bond prices already include a scenario where all the new administration's initiatives will be implemented, and their effect will last significantly longer than three years.

US macroeconomic statistics remain stable and indicate that the economy is growing confidently, and the reduction in inflation has stopped, not reaching the Fed's official target. Consumer prices rose in October by 0.2 and 0.3% for the main and core baskets, respectively, with inflation over the past 12 months at 2.6 and 3.3%. The expected pace of price growth by investors over the 5 and 10-year horizon is 2.4 and 2.3% per annum, respectively. This is above the September level and the Fed's target, but it is unlikely to indicate an irreversible rise in inflation expectations. The US labor market remains resilient: unemployment has stabilized at a historically low level of 4.1%, and the number of vacancies still slightly exceeds the number of unemployed. The number of new jobs in October increased by only 12 thousand, which could have alarmed investors if it were not explained by the negative impact of hurricanes. Unemployment benefit claims remain at a very low historical level, contrary to the statistics on the number of new jobs.

US GDP grew by 2.8% in the third quarter, with consumer and government spending components being the main growth drivers. A strong labor market and steadily rising wages, along with increasing lending volumes and a high budget deficit, support economic growth. Retail sales in October grew by 0.4%, outpacing forecasts.

Against this backdrop, the Fed continued to cut rates in November, reducing it by 25 basis points to 4.75%. Investors expect another cut in December, however, based on the macroeconomic picture we observe, this step seems premature. There is no indication of renewed progress in reducing inflation or worsening labor market conditions. On the contrary, concerns about rising inflation have intensified. It is worth noting that the 0.75 percentage point rate cut has de facto led to tighter financial conditions for the private sector, which most often borrows money in the form of long-term debt. The increase in Treasury bond yields by 80 basis points automatically led to higher refinancing costs for corporate borrowers, even considering some reduction in credit spreads, which played against the rate. Mortgages also became more expensive: the rate on a thirty-year loan rose from 6.2 to 6.9%, negatively affecting homebuyers. At the same time, household income from deposits, which account for about 7–9% of the assets of most households, should also decrease. The caution shown in Powell's recent statements gives hope that in December the Fed will take a pause in rate cuts.

Amid a stable US economy and apparent problems in other key regions, especially in China and Europe, American securities remain exceptionally expensive by historical standards. Bond credit spreads have updated the lows of the last 25 years, indicating a very low expected default level. Stock markets are also incredibly expensive. The equity market risk premium, calculated according to our methodology, remains in the negative zone, which preceded the largest market corrections over the past 100 years. The risk premium in Shiller's interpretation has fallen to 1.2%, indicating very low expected stock market returns in the future. At the same time, markets can remain very expensive for more than a year, and before the dot-com crisis, risk premiums fell significantly lower than they are now. At the same time, the situation where both debt and stock markets are as expensive as they are now is atypical. Before the Great Depression and the global financial crisis of 2008, at least one of the markets had higher risk premiums than now, leaving room for capital flow from one market to another. Before the dot-com crisis, bond markets were adequately valued, leaving room for capital flow from stocks, whose risk premiums were significantly lower than today's. Against this backdrop, despite uncertainty about future inflation, Treasury bonds offering a real yield of 2.1%* per annum remain an attractive alternative to investments in risky assets, at least while waiting for cheaper markets.

*The real yield of ten-year TIPS or the real yield of ordinary Treasury bonds, assuming that today's investor expectations for long-term inflation (2.3%) are correct.