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Wall Street's major indexes are deep in the red Tuesday as 10-year Treasury yields hold multi-year highs. Investors continue to grapple with the implications of an extended period of elevated interest rates and the potential economic repercussions, and they seem to favour the cut-run manoeuvre this week.

Heightened investor anxiety due to the looming possibility of a partial US government shutdown is not helping matters. Especially with Moody's, the rating agency, waving a red flag of caution that such an event could harm the country's debt rating. Shining a light on the USA's mindbogglingly reckless fiscal policy, where the deficit is expected to balloon to about $2 trillion for the fiscal year 2023, is enough to make anyone wince.

The surge in benchmark 10-year Treasury yields to their highest levels in 16 years follows the Federal Reserve's recent announcement of a more hawkish long-term rate outlook.

The forward earnings yield on the S&P 500 is currently at 5.5%. And now that the spread is less than 100 bps above risk-free returns on 10-year Treasury bonds, stock buying decisions are much more tricky for long-term investors. Indeed, the days of juicy 3-to-6 ppt spreads above Treasuries are a distant memory, and a regime change for valuations is probably well underway.

The VIX index, which measures stock volatility and is often called the "fear gauge," continues to rise. Outside of the rates markets shaking the VIX tree, the expected further increase in volatility over the next few weeks is valid, especially as we approach the critical October earnings season. Earnings season jitters are likely compounding the current "higher for longer' "sell-off "and encouraging folks to pull even more chips off the table. During this period, companies often announce whether they will surpass or fail to reach their full-year goals; hence, corporate earnings could be viewed as a place-setter and may dictate if there is any Santa rally this year.

Indeed, this lengthy and dirty laundry list of developments collectively contributes to the apprehension and volatility of the financial markets.

Investors have been able to swallow higher yields for some time. Still, when the primary driver behind the recent surge is a re-pricing of central bank reaction functions rather than improved growth prospects, risky assets tend to buckle badly, particularly long-duration stocks and assets (Gold) that struggle to absorb these central bank-driven yield increases. 

This week's equity market swoon is clearly tied to ongoing rate indigestion as investors push out rate cuts and pencil in a possible rate hike come Hallowmas.

OIL MARKETS

Oil markets managed to reverse early losses and ended the session on a higher note, supported by the WTI six-month calendar spread, which reached a nearly one-year high at $7.85 per barrel. Several factors, primarily centred around supply dynamics, contributed to this shift.

Specifically, the ongoing supply cuts by the OPEC+ coalition, combined with drawdowns in the Cushing tank farm located in Oklahoma, signal supply scarcity in the offing. 

The International Energy Agency (IEA) anticipates a supply deficit of 1.2 million bpd during the fourth quarter. Increasing the “scarcity premium,” foreign buyers have had a strong demand for crude oil, reducing inventory at Cushing. According to the Energy Information Administration (EIA), stocks at Cushing hit a 14-month low of 22.9 million barrels on September 15th. 

FOREX MARKETS

FX traders continue to ride the Fed's updated projections, which stand in contrast to several other central banks, such as the ECB and BoE, and are likely to influence market dynamics in the coming months.

This tilted reaction function of the Fed implies that the Euro and Sterling could weaken more on an unfavourable mix of EU and UK economic news, as it may suggest that less restrictive monetary policy is needed. Conversely, the US Dollar's reaction is expected to be positive, given the Fed's focus on whether inflation can return to target without further economic slowing.

Gold Markets

In August, China's gold imports through Hong Kong showed a resurgence compared to the previous month. This import increase is attributed to issuing new quotas to local banks, which is expected to bolster shipments into China, the world's leading gold consumer. This will likely take the edge off the Shanghai premium just in time for Golden Week.

However, some traders think the record-high Renminbi (RMB) gold price could negatively impact local gold consumption in China. The continuous increase in gold prices within China has acted as a significant deterrent to demand recovery in 2023, and it may persistently dampen consumer interest. This situation could result in weaker-than-expected sales during the traditional boost seen during the upcoming Golden Week, a prominent holiday in China.

However, typically, the Chinese market appears to be more responsive to changes in the dollar-denominated price of gold than the renminbi (RMB) price. This sensitivity to the dollar price of gold underscores the global interconnectedness of the gold market and the influence of international pricing on Chinese demand and import patterns. Hence, buyers in Asia could welcome a move to $1850 -75 on the back of higher US yields.

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