November 28, 2023
Month-end rebalancing dynamics are in play with pension funds better to buy bonds given performance differentials. This may help explain some of yesterday’s pullback in bond yields despite relatively heavy issuance.
The prevailing soft landing narrative includes expectations for 100bp of rate cuts in ’24. The presumed rate cuts have been driving recent dollar weakness and gold strength (XAU). Gold is priced in dollars, so dollar weakness gets you higher gold prices. Demand for gold in China is also up ~12% YoY given limited onshore alternatives amid downbeat investor sentiment. Of course, a soft landing is not always bearish for the US dollar (USD). Consider that 100bp of Fed rate cuts would still leave USD with a higher yield than 40% of global FX.
The S&P 500 (SPX) is consolidating recent gains as month-end pension rebalancing favors an allocation to bonds over stocks. Month-end rebalancing is only a factor this month given the wide performance differential between the two asset classes. We’d expect the rebalancing will be largely finished by tomorrow afternoon. Thursday brings two important inflation reports with the release of flash November Eurozone CPI and October US core PCE. The highest probability risk to equity markets would still come from a surge in bond yields. Benign inflation data that holds bond yields at current levels or lower will likely result in equity upside until markets turn their attention to the November Jobs Report due on 12/8.
Ten-year bond yields reached a cycle peak near 5% in mid October after a month-long period when yields became disconnected from their fundamental drivers. We operated under the assumption of a cycle peak in yields until it was confirmed when 10-year yields broke below 4.48%. Ten-year yields have now reached another small milestone at 4.35%. A break below this level would put next level support at 4.18%. We expect any decline in bond yields will be relatively small given ongoing QT operations and the apparent price sensitivity of foreign demand.