We've seen a total turnaround in sentiment in the first two days of Q4 trading. The theme is the market growing increasingly convinced that central banks won't hike as high as feared and that inflation will be controlled.
There's no certainty that will indeed be the case but here's why markets think it's coming:
1) The market moves in late Sept indicate strain
It was an ugly close to the month in bond and stock markets. The Bank of England was forced to ride to a short-term rescue and new lows in equities at the time that companies are setting 2023 budgets ensures some level of capex restraint. The shock of it all will do some of the Fed's work in restraining demand.
2) Economic data softening
We've had two data points this week that have undershot expectations: ISM manfacturing and JOLTS job openings.The manufacturing data showed a significant fall in prices and job openings fell by the most on record. That will indicate to the Fed that its actions are working.
3) It's not just in the US
Arguably, the biggest driver in the changed picture today is the Reserve Bank of Australia hiking rates by 25 basis points versus 50 expected. Governor Lowe had offered a hint of this previously and noted that global growth was slowing rapidly. Those factors are visible to central banks everywhere and commodity prices are transparent. Add it all up, include continued improvement in supply chains and their work is mostly done.
Notably, there's no one at the Fed that's truly acknowledging a shift but today new Fed governor Jefferson said that supply-demand conditions in labor market and economic seem likely to ease some and that they've seen some improvements in supply chains. Expect more of that going forward.
But the market isn't waiting for the confirmation. The terminal Fed funds rate is now at 4.47% in March, down from +4.70% two weeks ago. The odds of just a 50 bps hike on November 2 are up to 25% from nil. In the eurozone, the rate pricing for June 2023 fell 20 basis points yesterday alone.
4) Fiscal tightening
This is the one that no one is talking about. The rout in government bonds in late September sent a strong message to governments that the era of free money is over. I think that message has been received.
There aren't the same metrics on fiscal pricing as monetary so this is more art than science but the UK is going to roll out a medium-term fiscal plan in November and pressure elsewhere is rising. I don't know if this ends in another era of austerity but the Truss government losing fiscal credibility was political suicide and a wake-up call for politicians everywhere.
That's ultimately a drag on short and medium-term growth but if it means that central banks need to do less, it could balance out.