Global bond yields continued to surge higher in September, led by the US, as markets started to price in the likelihood of a 'higher for longer' interest rate policy. This led to a sharp increase in the difference between short and long-term rates or a steepening of the curve as central banks extend their policy cycles. On the back of this sell-off, the Australian bond market, as indicated by the Bloomberg AusBond Composite 0+ Yr Index, experienced a decline of -1.53%.
Volatility in the bond market continued until late in the month, as the gains from August were quickly eroded as the market pushed to new year-to-date lows. During their September meeting, the Reserve Bank of Australia maintained their cautious stance by keeping the interest rate at 4.10%. By the end of the month, the yield on the AU3Y government bond increased by 34 basis points to 4.08%, while the AU10Y yields rose by 46 basis points to 4.49%.
The realisation that rates will have to stay elevated for an extended period is starting to establish itself with expectations of marginally more tightening by central banks but a prolonged economic cycle. Futures markets are currently anticipating only one more interest rate hike from the RBA by April 2024, with no plans for rate cuts that year, with similar expectations in US markets. Long-term yields have surged, with some now trading above pre-2008 financial crisis levels. The Australian yield curve has steepened, and the US curve has become less inverted in recent weeks.
Uncertainties remain in the global economy. The recent increase in oil prices has stoked debate about the possibility of inflation returning. Specifically, Australia's monthly CPI data was primarily influenced by a rise in fuel prices. With inflation at an annualised rate of 5.2% and the core measures showing moderation, the RBA will observe the situation rather than take immediate action. The labour market is starting to cool off, but it is worth noting that it started from a high level, indicating only modest wage growth. Leading indicators such as the underemployment rate, job vacancies, and job advertisements are pulling back from recent highs and starting to moderate. The unemployment rate in Australia is currently at 3.7% and remains within the range of full employment.
Economic growth in Australia is inconsistent with the second quarter GDP meeting expectations, with a YoY increase of 2.1%. However, household spending was moderate, and inventories were significantly decreased. Public investment helped offset this, but overall, the growth rate for the quarter was below average at 0.4% vs the previous quarter. Net exports have been a positive factor, but they are slowing down, and imports are declining even faster. This trend is expected to continue due to the decrease in the value of the Australian dollar. Despite some temporary entertainment-related spending, the consumer sector remains weak. Momentum is slowing down, and the decline in aggregate savings results from past consumption. Real disposable income is also decreasing, indicating that this trend will likely continue.
Global markets were pessimistic during the month as investors returned from their summer break and were faced with an unclear macro outlook, which is typical for this time of year. Investor confidence was also affected by a significant increase in yields and mounting evidence of a slowing global economy. Market participants reconsidered the likelihood of a smooth economic transition as they contemplated a wider range of possible outcomes. One potential scenario gaining credibility is weaker economic growth coupled with a prolonged period of high interest rates to counter persistent inflation (stagflation), which could negatively affect various risky investments.
September Market Summary
- US stock markets posted negative quarterly performance for the first time since the third quarter of 2022
- The US Dollar posted 11 consecutive weeks of gains for its second-longest up-trend in the past 50 years
- Oil markets advanced higher, with WTI Crude up by +29% in Q3
- Long-term US Treasury yields rallied, trading up to 2009 levels
- Futures markets are only pricing a 30% chance of one more rate hike from the US Fed this year
US Equity Markets
August and September have gained a reputation in equity markets for poor performance on a seasonality basis due to consistently negative monthly returns on average dating back to 1970. Out of all the months, only September has had a negative average monthly return during this 50+ year period. The major US equity benchmarks lived up to this reputation by experiencing declines in August and September, marking the first time since Q3 2022 that they had a quarter with negative returns. The Dow Jones performed relatively well compared to other benchmarks in both September and Q3, while the smaller cap Russell Microcap and Russell 2000 indices performed the worst in these periods.
Mega-Cap Performance
At their July highs, the Nasdaq-100 and S&P 500 came within 5% from the prior all-time highs set in late 2021 / early 2022. After the recent weakness ending Q3, the Nasdaq-100 stands at +41% from its 52-week lows. Conversely, in the last week of September, the Russell Microcap Index broke a 15-month support level to a new cyclical low while the Russell 2000 resided in the lower third of its prior 15-month trading range.
The strong year-to-date gains in the large-cap benchmarks are influenced mainly by a select group of mega-cap stocks. These companies, referred to as the 'Magnificent Seven', have significant representation in the Nasdaq 100 and S&P 500 indices, accounting for 43% and 27% respectively. Moreover, the Bloomberg Magnificent Seven Total Return Index has seen an impressive +84% performance year-to-date.
Sector Disparity
The sector level also shows a tale of disparity, with five out of eleven sectors experiencing losses year-to-date. Communications and Technology have seen positive gains of 40.4% and 34.7%, respectively, while the defensive sectors of Utilities and Consumer Staples have seen declines of 14.4% and 4.8%. In a market where 12-month Treasury bills are yielding over 5%, the higher-yielding defensive sectors are not as enticing compared to the Zero Interest Rate Policy or ZIRP era. September saw declines in ten out of eleven S&P 500 sectors, and nine out of eleven sectors were down for the entire third quarter. Energy and Communications performed well during the quarter, while Utilities, REITs, and Healthcare were the weakest performers.
US Treasuries
Volatility continued in the US Treasury market, with the US30Y yield surging higher by 84 basis points in Q3, making it the largest quarterly gain in over 14 years. This surge also brought it to its highest level since 2011. The US10Y yield also saw a gain of 74bps in Q3, reaching a peak of 4.69%, which is the highest it has been in the past 16 years. As the Federal Reserve nears the end of its rate hike cycle, the shorter-term US2Y yield only rose by a modest 15bps. There has also been a 'bear steepener' trend throughout the third quarter. After hitting a low of -108bps in both March and June, the spread between the US10Y and US2Y UST has gradually increased. In the last seven sessions of the month following the September 20th FOMC meeting, the spread steepened by an additional 30bps, closing the quarter at -47bps.
Oil Markets
Energy prices have surged due to the supply cuts implemented by OPEC+ and Russia. WTI crude oil rose by 29% in Q3, and up to 40%, from the last week of June to the peak in late September. The rise in energy prices hurts consumers and businesses, hindering future economic activity and reducing the chances of a smooth economic transition. Both petrol and heating oil prices saw significant increases of 41% and 37%, respectively, while natural gas prices in the EU rose by 13%. Precious metals such as gold and silver saw declines of 4% and 2%, respectively. The performance of industrial metals varied during the third quarter, with aluminium increasing by 7% and palladium increasing by 3%. However, nickel (-8%), steel (-3%), and copper (-0.1%) all experienced decreases.
The US Dollar
The US Dollar Index (DXY) ended Q3 by achieving eleven straight weeks of gains, the second longest streak in over 50 years and trading to fresh all-time highs in 2023. Despite the impressive run higher, it is important to monitor the greenback's performance due to its strong negative correlation with the S&P 500. The DXY experienced a relatively modest increase of 3.2% for Q3, with the dollar appreciating against nine out of ten G10 currencies and most emerging market currencies.