October 18, 2023
A quick update on the recent market moves and anything that might have changed on either the momentum or reversal model.
The bond market sell-off continues, with 10-year yields back at the recent highs, looking like eyeing up a move to the 5%-handle.
The reason for the recent continued battering was the 0.7% increase in headline retail sales in September, which was much better than the consensus expectation of a 0.3% rise and some forecast (see ATW from Monday), which was based on the weakness of the near real-time card transaction data. There were also upward revisions to previous months' gains, which means that even adjusting for inflation, retail sales appear to be on a renewed upward trend and on a much stronger path than pre-pandemic trends would imply (see chart below).
Unlike last month, the increases in September were widespread. Gas station sales rose by 0.9%, which was mostly a reflection of higher gas prices. Spending on autos rose by 1.0%. Control group sales - which exclude gas, autos, food, and building materials and feed directly into GDP - were up by a stronger 0.6% and rose by 6.4% annualized in Q3, up from 2.4% in Q2. That is consistent with a sharp acceleration in consumption growth.
The strength of retail sales mostly reflects increased spending on goods, but the US retail sales report also includes food services spending at bars and restaurants, which rose by a solid 0.9% in September. That is a sign that broader spending on services remained solid throughout Q3.
Looking at the detailed breakdown, spending growth was led in the third quarter by spending on restaurants and bars, as well as online (chart below). The jump in gasoline prices explains the strong rise in spending at gas stations. The renewed downward pressure on the housing market from rising interest rates is clear in the breakdown, too, with housing-related categories of spend struggling in Q3, with sales of appliances only edging higher, building material spending flat, and spending on furniture contracting outright.
The market still expects the Fed to stand pat at its meeting at the end of this month, reflecting the continued downward trend in core inflation. But the continued resilience of economic activity, and the job market in particular, will raise concerns on the committee that the downward trend in underlying services inflation could reverse. That will keep officials sounding hawkish and leave the door open for additional rate hikes at the December meeting and potentially beyond. Remember that Powell speaks this Thursday, so we will hopefully get some reaction from him in response to the fact that nominal growth is still unambiguously strong.
The market still has roughly a 50% probability for the Fed to hike once more this year, while the market has now priced out quite a chunk of rate cuts next year, with 65 bps worth of cuts still in the curve.
There was also a relatively hawkish news combo that hit late in the Asia day on Tuesday. Bloomberg reported that the BoJ will consider raising inflation forecasts for 2023 and 2024 at the October 31 meeting, which comes on the heels of an NHK story that Japan’s largest labour union will push for even larger 2024 wage increases than last year. The hawkish double-whammy did little to move USDJPY, which remains beholden to US real yields and jammed against MoF's suspected 'pain point' at 150. Meanwhile, the JPY 10y swap marched 4bps higher back to 1%.
Now, let’s look at our charts and what we should focus on.