In the last month, and in particular during the last couple of weeks, we have observed an unusual combination in price action, with a rise in equity and sovereign yields and at the same time an increase in gold and oil prices, thus breaking historical correlations and preparing the ground for an inevitable correction.
Let’s start with equity markets. If we look at the performance of the major indices in the last month, the MSCI World Index has gained 5.11%, around a third of the 16.7% growth it has recorded year-to-date. The S&P 500 has gained 6.3%, which is about a third of its 20.6% gain since the beginning of the year, while the Eurostoxx 50 has gained 4.6%, half of the 9.6% it has gained since January 2024. But the real stars of the last month have been the Chinese indices. Hong Kong’s Hang Seng has gained 30.3% in a month, making up almost the totality of the 33.4% increase it has recorded since January. In mainland China, the Shanghai stock index has managed to reverse its previous decline: a 20.6% increase in the last month has brought its yearly performance into positive territory, with a 12.5% gain year-to-date.
As equity indices were rising, sovereign bond yields also rose. When, in mid-September, the Fed decided to cut the benchmark Fed funds rate by 50bps, surprising the market to the upside, yields initially fell: the 2-year US Treasury yield dropped from 4.00% to 3.50%, while the 10y UST yield initially fell before rising back up in consideration of the reduced risk to growth (and potentially the higher risk to inflation) deriving from the move. But in the last couple of weeks, the 2y UST yield has been rising more markedly, reaching 3.92% on Friday, after the higher than expected Non-Farm-Payroll figure for September. Meanwhile, the 10y UST yield has also reached 3.97% over the same period.
In the commodity space, gold has continued to beat all previous records. One year ago the gold bullion was just over $2000, and one month ago it was $2500. In late September it reached $2706, and is now trading at $2673. This movement represents a rupture to the historical norm (or more simply correlation) that sees a rise in UST yields associated with a fall in gold prices (as gold does not pay interest and does not guarantee a return). Meanwhile, Brent oil prices have increased from $69 per barrel in early July, and is now trading at $79.
The most interesting question is what is behind this bipolar – one could say schizophrenic – behaviour of markets, which on the one hand exhibit the typical risk-on features (higher equity and oil prices and bond yields) and on the other hand shows a record-high level of risk aversion? There are several factors at play here, which can explain this unusual combination of price actions.
First, the US economy, which seemed on the verge of a recession until the summer, is actually proving much stronger than expected, as testified by the 354K increase in NFP in September, much higher than the 140K consensus or the previous reading of 159K. This has served to dissipate the doubts that the Fed had cut rates by more than expected in September as a sign of panic for the rapidly deteriorating economy. By the way, the larger-than-expected cut (and the consequent decline in bond yields) did provide a boost to risky asset prices.
Second, the massive monetary stimulus introduced by Chinese authorities in the two weeks preceding the country’s October 1st National Day celebration (which opens up the so-called golden week) helped push Chinese equity markets up, and boost all other equity indices, driven by an expected improvement in the Chinese economy as well as a much-needed kick to the luxury sector in developed economies.
On the other hand, in the commodity space, the rise in gold prices signals the increased risk aversion by investors, which observe a combination of nasty geopolitical developments, with no end in sight, in both the Middle East and Ukraine, as well as the risk of higher inflation, as well as deflation, ahead. Gold is traditionally considered a good hedge against inflation, but offers even better protection in case of deflation, being an asset with no corresponding liability (as in the case of equities or bonds), and therefore offering protection against counterparty risk.
The rise in oil prices can be explained by a combination of two opposing forces conjoining to send them higher. On the one hand, stronger than expected global demand (from both US and China) incentivise oil production and consumption. On the other hand, rising geopolitical tensions, especially in the Middle East, lead to higher oil prices, as people expect reduced supply, in particular possibly from Iran.
