It was, by all measures, a challenging October 2023 for the financial markets, especially for risky assets as the global bond market sell-off triggered broad-based volatility across risk assets over the past month. Certainly, the sudden escalation of conflicts in the Middle East, which started on 7 October 2023, heightened risk aversion, boosting safe-haven flows into USD, Oil, CHF and Gold. The rise in the benchmark 10-year US Treasury yields beyond 5% occurred for the first time in 16 years on 23 October 2023 [1]. But this upward movement was quickly reversed as financial markets finally relented and adjusted to the prospect of higher rates for longer duration, and the yield curve steepened as investors demanded more compensation for long-term lending.

Meanwhile most central banks appeared to be on hold, especially in Europe as U.S. economic data and a recent third-quarter corporate earnings report in the U.S. continue to show resilient even in the face of higher rates and borrowing costs.  However, towards the end of October 2023, the U.S. equities entered a technical correction, with the S&P 500 Index closing 10% [2] (27 October 2023 below a recent peak, as investors grappled with rising volatility and hotter inflation numbers, which underscored expectations that the Federal Reserve is poised to keep interest rates high). In Asia, BOJ kept rates unchanged and eased its grip on long-term rates by further loosening its bond yield control policy (YCC) on what analysts viewed as insufficient while China is also set to raise its 2023 budget deficit ratio to 3.8% from 3% [3], the highest on record, and will issue extra CNH1 trillion sovereign bonds in Q4, the same amount as previously reported by Reuters (25 October 2023) as an added stimulus which is much welcomed by the markets especially for Hang Seng.

Views on Fixed Income

The fixed income market has recently undergone a significant transformation, characterised by a notable development: 10-year U.S. Treasury yields have exceeded 5% for the first time in 16 years. This extraordinary surge in yields can be attributed to three primary factors: policy rate expectations, the natural rate, and the term premium, as mentioned in a UBS Daily House View report [4].

The initial factor, policy rate expectations, is driven by the Federal Reserve’s shift toward a “higher-for-longer” scenario for 2024, reflecting the economy’s resilience and persistent inflation. This shift has resulted in rate increases and a steadfast commitment to maintaining elevated rates. The second factor, the real natural rate, is influenced by robust consumption and fiscal expansion, leading to reduced savings and heightened market-based indicators of the natural rate. Lastly, the term premium has been on the rise due to apprehensions about the US fiscal situation. In the near term, further increases in the term premium are plausible, given the prevailing uncertain political landscape.

In recent months, we have favoured short-duration investment-grade instruments, a strategy that has demonstrated simplicity and effectiveness. Given the current yield levels, we now consider modestly extending the duration of fixed income portfolios (not longer than 10 years). This adjustment not only offers the potential for improved returns, but higher outright yield levels which provide more buffer against mark-to-market volatility. Furthermore, considering the possibility of further term premium increases, the inclusion of yield steepening strategies in the portfolio can still provide value and enhance the overall investment approach.

Views on Equities

A combination of underwhelming earnings from major tech giants, cautious outlooks, and rising bond yields has put pressure on the equity markets. On 26 October 2023, the S&P 500 reached its lowest point since June 2023, and the Nasdaq saw its most substantial daily drop, declining by 2.4% on 25 October 2023 [5]. Notably, the BofA Bull & Bear Indicator has fallen from 1.9 to 1.5, marking its lowest level since November 2022 and signalling a contrarian “buy signal” for the second consecutive week [6]. When analysing historical seasonal patterns, we observe that the median return for the S&P 500 in November has historically been around +1.50% dating back to 1928. Additionally, for the Nasdaq, the median return in November has averaged approximately +3.86% since its inception in 1985. We consider the current market pullback as an excellent opportunity for investors to consider investing in solid, undervalued companies with a stable outlook and significant potential for free cash flow growth. Moreover, investors can explore capitalising on increased market volatility with put options on select stocks.

In Europe, a substantial portion of STOXX 600 companies have reported their third-quarter results. Sales and earnings per share generally align with expectations, although it is important to note that consensus estimates have been rather conservative. While the number of companies surpassing or falling short of consensus estimates is consistent with historical trends in terms of earnings per share, there is a notable proportion of negative surprises, closely mirroring historical averages. Earnings momentum remains just below 0%, indicating that consensus estimates continue to be revised downward [7]. Given the headwinds facing Europe, such as weak domestic and international demand, higher inflation, and slower growth, we anticipate that the trend of decreasing earnings per share forecasts will persist, possibly leading to further declines in European stocks. Investors might want to look to consider relatively cheap put options to take on this view.

Views on Currencies

October 2023 started off in a familiar fashion, with FX markets trading range-bound and the dollar trading closely to the economic data released.  In the middle of the month, global bonds were sold off especially for the U.S. treasuries, as yields continued to spike with the benchmark 10-year trading to a 16th year higher on the October 2023. Meanwhile, the world was in shock after conflicts started in the Gaza strip. As events continue to unfold, volatility spikes have affected risk appetite resulting in the outperformance of safe-haven currencies, especially Gold on 30 October 2023.

The U.S. Dollar Index (DXY) continued to climb higher to above 107 (3 October 2023) as traders took the dollar higher due to the spike in yields and the geopolitical conflicts in the Middle East. However, towards the end of October 2023, DXY eased somewhat to 106.60 (30 October 2023) as 3rd quarter’s earning season surprised on the upside despite the high rates showing a resilient U.S. economy.  Throughout October 2023, USD traded mixed against its major peers. It was better bid against most major currencies while under-performed against safe-haven currencies like CHF and Gold.  The uncertainty surrounding the Middle East crisis and higher treasury yields did not benefit the CNH and most Asian currencies which vastly underperformed.

It is noteworthy that volatility spiked significantly towards the end of October 2023, especially with Gold volatility trading at 16-17Vols compared to 13-14 vols in September 2023. Meanwhile, funding currencies had mixed performances, the Swiss Franc (CHF) strengthen significantly on risk aversion but seems to have stabilised above 0.9 (30 October 2023). The Chinese Yuan (CNH) traded sideways while Japanese Yen (JPY) remained weak trading at above 151 (31 October 2023)  with no actions of verbal intervention form the Japanese authorities after BOJ left rates unchanged after their policy meeting.

  • Japanese Yen (JPY): No significant change, and given the yield difference, it’s unlikely the JPY will appreciate was markets were disappointed with BOJ lack of stronger policy changes The potential range is expected to be between 145 and 155. With potential of a possible intervention in play

  • British Pound (GBP): We suspect more consolidation will take place ahead for the GBP.  We continue to see weaker economic data. The possible range is 1.1900 to 1.2400.

  • Euro (EUR): No new developments on Euro as it continues to trade on the weaker side in a lower sideways pattern. The likely range is 1.0400-1.0700.

  • Swiss Franc (CHF): The currency recovered most of its losses in September due to the conflicts in the Middle East. It is likely to consolidate around the 0.89-0.92 range. Risk for a wider conflict which could push USD/CHF lower.

  • Australian Dollar (AUD): China’s latest stimulus may have helped the stability of the currency as CPI data surprised on the Upside. There were talks of a potential 23 November 2023 rate hike of 25bp by RBA. We see a base now for the AUD at 0.63 but unlikely to trade much higher with further consolidation expected potential range of 0.6300 to 0.6500

  • Chinese Yuan (CNH/CNY): Both the offshore and onshore Chinese Yuan are likely to consolidate on the weaker side, staying above 7.2. There has been more scrutiny from the Chinese government of late with a visit from President Xi (25 October 2023) to PBOC and the FX oversight body. Hence topside is likely to remain cap to 7.35. Potential range 7.25-7.35.

  • Singapore Dollar (SGD): Trading weaker side of recent SGD NEER and should consolidate further. Potential range 1.3600-1.3800.

Source:

[1] https://www.straitstimes.com/business/us-treasury-10-year-yield-breaches-5-for-first-time-since-2007#:~:text=Oct%2024%2C%202023%2C%206%3A45%20PM%20SGT%20SYDNEY%20%E2%80%93,further%20boost%20bond%20sales%20to%20cover%20widening%20deficits.[2] https://www.wsj.com/livecoverage/stock-market-today-dow-jones-10-27-2023?mod=hp_lead_pos2
[3] https://www.reuters.com/markets/rates-bonds/china
[4] UBS Daily Asia – UBS House View 24 October 23
[5] S&P 500, Nasdaq end sharply lower as Alphabet disappoints, Treasury yields bounce | Reuters
[6] BofA Global Research – The Flow Show 26 October 2023
[7] Societe Generale Research – Initial takeaways from the 3Q 2023 reporting season in Europe 26 October 2023

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