Weekly house view | Victory for Europe

Congress’s vote on Sunday to avoid a US government shutdown averted an immediate crisis but not economic and financial uncertainty. Heightening concerns for markets, the Speaker of the House of Representatives faces a possible vote on his leadership for brokering the deal. The tense talks in Washington played out against an equally fractious Ryder Cup, won by Europe. Highlighting markets’ nervousness, the VIX Index of volatility hit its highest level since May last week. Markets jitters saw the 10-year Treasury yields rise in September from 4.1% to 4.57%, increasing investment competition for stocks, as Federal Reserve officials talked about rates staying higher for longer. Thus, the S&P500 lost 5%¹ (in USD) in September, the Nasdaq dropped 5.8%² (in USD) and small caps even more. We are underweight small caps, which are more sensitive to rates as they have a higher share of floating debt. Treasury yields, near multi-year highs, eased slightly on Friday on news that the core PCE price index, the Fed’s preferred inflation gauge, eased to 3.9% on a yearly basis in August from 4.3% in July. However, updated second quarter GDP data showed a sharp downward revision to consumer spending. Near-term risks point to lower growth and possibly higher inflation, meaning the Fed is likely to proceed carefully and retain a hawkish bias.

In Italy, bond vigilantes showed they are back and ready to impose discipline on policymakers through higher yields. Italian 10-year yields rose to 4.95% during the week before closing at 4.78% as the Italian government lifted its 2023 and 2024 deficit projections. UK 10-year yields jumped too, with high oil prices fanning concerns in bond markets that persistent inflation could keep rates higher for longer. We maintain our USD 95 Brent year-end target. In the euro zone, headline inflation eased to 4.3% in September from 5.2% in August. In bad news for growth, euro area economic sentiment fell for a fifth consecutive month in September. We expect the ECB to keep rates on hold.

In Japan, the finance minister said the country won’t rule out any options to deal with excessive currency volatility, reiterating a warning against speculative moves on the yen. Bank of Japan (BoJ) Governor Kazuo Ueda said considerations over the central bank's finances would not prevent it from phasing out its monetary stimulus when the appropriate time comes, adding that there was "still a distance to go" before the BOJ exits its ultraloose monetary policy. The Nikkei ended last week at a one-month low and the 10-year government bond yield hit a 10-year high before closing at 0.765%. While the BoJ is likely to normalise its monetary policy, the pace of normalisation could be very slow in an environment in which the inflation outlook is still highly uncertain.