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MARKETS

Despite a U.S. equity market wobble, TINA still stands tall.

Wall Street wobbled last week, with indices stumbling amid anticipation of a likely hawkish tilt from the Federal Reserve at this week’s meeting. Amidst climbing yields, where 10-year bonds touched 4.40%, investors have sharply recalibrated their outlook. The financial markets, once dismissive, now keenly recognize the simmering resurgence of inflation.

The swap markets have pared back expectations, cutting the forecasted Federal Reserve rate reductions from an initial 100 basis points to just 75 for 2025. Moreover, the buzz on the trading floors suggests a further narrowing to merely two cuts next year. This recalibration is fueled by the looming spectre of President-Elect Donald Trump’s America First agenda, which threatens to redefine the economic terrain with substantial tariffs and tax reforms, prompting traders to brace for significant shifts.

Under the daunting rise of yields, U.S. equities remain a magnet for massive capital inflows. In the latest reporting period, ETFs and mutual funds dedicated to U.S. stocks pulled in an impressive $13 billion, marking an unbroken streak of ten consecutive weeks of inflows—accumulating over 12 of the last 13 weeks. These funds are on track to shatter records with over $480 billion in inflows for 2024, as per the latest tally from Bank of America. This surge underscores the unyielding global confidence in the "There Is No Alternative" (TINA) narrative, as U.S. equities stand as pillars of stability against the backdrop of Europe and China's economic tremors. Moreover, the pivotal role of U.S. markets in driving forward the AI sector narrative only bolsters their appeal, cementing their status as the go-to arena for investors seeking growth and security.

The key takeaway from last week, the U.S. inflation figures for November, aligned with expectations yet sustained a distinctly toasty undertone. The headline CPI inflation quickened to 2.7% year-over-year, marking a second month of rising rates, while core inflation was entrenched at 3.3% year-over-year for the fourth consecutive month. This consistency in core inflation, which has been running at an annualized rate of 3.7% over the last three months—up from 2.9% over the previous six—suggests that underlying price pressures might be solidifying. Despite these figures, expectations persist for the Federal Reserve to enact a 25 basis point rate cut on December 18, as rates remain significantly constrictive. However, the road ahead could get decidedly bumpier if 2025 continues to unfold with robust growth and potentially higher inflation figures.

China's Stimulus Dilemma: “You can lead a horse to water, but you can't make them drink.”

The recent blaze of glory in China's stock market, where equities soared an eye-popping 35% in just two weeks, has quickly fizzled into a cautionary tale of speculative frenzy meeting reality. This rollercoaster ride, ignited by fervent hopes of aggressive government stimulus, saw its spark extinguished as swiftly as it was lit, leaving investors in a lurch. Despite the fanfare surrounding Beijing's promises to rejuvenate consumer spending and stabilize its shaky economy, the lack of substantial follow-through has sent a chill through the market.

After their fleeting ascent, Chinese equities have turned less optimistic, reflecting a deep-seated investor skepticism towards the government's lofty pledges. The aftermath of the Central Economic Work Conference, heavy on grandiloquent vows yet scant on concrete steps, only deepened this distrust. As the echo of these promises fades, the cold reality sets in, casting a long shadow over the financial landscape. And don’t say we didn’t warn you to Beware of China’s Stimulus Syndrome and in Forex Markets China Stimulus—Another False Dawn?

In the bond realm, the plummeting yields on China’s 10-year notes sound alarms louder than any ceremonial gong, hinting at deep investor fears of deflation taking root. The stark drop in new yuan loans issued in November further underscores the grave economic challenges ahead. Even with lower interest rates, the gears of China’s economic consumption engine remain stubbornly jammed. Indeed, “you can lead a horse to water, but you can't make them drink.”

The pressure mounts for more than verbal magic as Beijing’s economic narrative unfolds under the world's watchful eyes. With 2025 looming, the global financial community remains on tenterhooks, awaiting real action to enable a robust economic recovery or see China’s winter of discontent stretch indefinitely, compounded by the return of President-elect Donald J Trump, who will most certainly hit China's shares with the U.S. tariff hammer.

Some Commodities Could Still Fly on China’s next round of “ Stimmy”

Nonetheless, the stimulus pumped up the Chinese economy and could still herald a promising year for most commodities. However, the direct benefits and linkages to these economic measures may weave a more intricate tapestry than initially meets the eye.

Beijing's latest proclamation rides the wave of two major shifts: the economy's encouraging rebound and the looming shadow of increased U.S. import tariffs under incoming President Donald Trump. Though details remain under wraps, the anticipated stimulus is poised to invigorate the economy's fragile segments—housing, SMEs, and consumer markets—while turbocharging efforts towards sustainable, green energy solutions.

The potential for increased government initiatives to expedite the completion of pre-sold housing projects or boost electric vehicle (EV) uptake could significantly brighten the prospects for commodities like copper and battery-centric materials such as nickel. These materials stand to gain considerably, though the broader demand for industrial metals outside of China continues to lag, with swelling exchange inventories signalling a looming surplus—the most substantial in over a decade for refined copper.

This scenario sets a challenging stage for metal prices in 2025, which are expected to trend modestly downward due to persistent global trade tensions and a strengthening U.S. dollar. Conversely, a surge in Chinese EV sales could exert further downward pressure on crude oil prices. The drastic slowdown in Chinese oil demand, which saw a rise of only 150 kb/d in 2024 compared to 1.4 mb/d in 2023, has significantly impacted benchmark West Texas Intermediate (WTI) crude prices.

Meanwhile, OPEC+'s deliberations on when to reintroduce 2.2 mb/d of voluntary production cuts back to the market are crucial. Currently deferred to April 1, 2025, this timeline for increasing production might be prematurely optimistic and could push out our expected Brent price drop to sub $65 per barrel deeper into 2025.

However, considering the apparent discontent among OPEC members, especially those facing fiscal challenges, it's conceivable that Saudi Arabia might relent and allow more barrels to flow as early as April. This possibility becomes even more likely if U.S. production continues its upward trajectory, adding further pressure on OPEC+ to adjust its strategy so as not to lose out on market share.

Indeed, an escalation in stimulus measures could invigorate China's economy and buoy commodity markets, except crude oil.

Last week, oil bulls seemed to catch a break amid rumours of intensified sanctions targeting Russian oil production ( as per our recommendation last week that oil futures should not be sold). Without this speculation, oil prices might have dipped, tracking the downtrend in China's equity markets and the bearish sentiment surrounding Asia's major oil-importing economies and their weakening currencies.

FOREX MARKETS

The dollar has strengthened against most G10 currencies this week, with the yen and Swiss franc lagging, notably highlighted by the Swiss National Bank's 50bps rate cut and dwindling expectations for a Bank of Japan rate hike this Friday.

It seems unlikely that Japan would choose to hike rates and risk significantly strengthening the yen, given the weakening currencies of its Central Asian export competitors.

Even with the anticipated Fed rate cut this week, the dollar is expected to maintain its strength. This support will likely come from cautious commentary by Fed Chair Powell and a likely reduction in the median dot in the Summary of Economic Projections from four cuts to three.

Policy divergence should then continue to favour the dollar. However, I believe the dollar will climb even higher as we near inauguration day, driven by the likelihood of a barrage of tariffs from Trump as his first order of business. This move could shake currency markets globally.


CHART OF THE WEEK

Will higher tariffs result in higher interest rates?

Investors are bracing for the potential ripple effects of further tariffs and are concerned about possible spikes in inflation and interest rates. However, David Mericle, Goldman Sachs Research's chief US economist, suggests these risks might be more balanced than anticipated. On a recent episode of Goldman Sachs Exchanges, Mericle analyzed an investor survey on policy expectations under a potential second Trump administration. ( full article)

He emphasized that the expected impacts of tariffs on inflation are relatively modest. Reflecting on 2019, when the Trump administration first introduced tariffs, Mericle noted that the Federal Reserve focused more on the risks to economic growth from tightened financial conditions than on the moderate, one-time increase in price levels. "The risks may not be as one-sided as people think," he concludes, offering a nuanced view of the interplay between tariffs, inflation, and monetary policy.

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