Overview
1. The Federal Reserve (the “Fed”) signals gradual tapering by year-end
2. Central banks keep rates low despite inflationary signs
3. Growth slowed by Delta variant and supply chain bottlenecks
4. Eurozone economy surpasses the US and China in Q3
5. Oil rallies amid tight supply and surging demand worldwide
6. Equities rise despite mixed earnings
7. Apple and Amazon miss earnings amid supply-chain constraints
8. Sentiment declines amid inflation and supply chain concerns
Policy & Geopolitics
The Fed signals gradual tapering by year-end
The Fed is preparing to announce their plan to reduce their $120 billion monthly asset purchases in the November meeting after indicating in September that the economy is near the Fed’s goals. The Fed is likely to start cutting its purchases of Treasuries in mortgage-backed securities by $10 billion and $5 billion, respectively, each month and end purchases by mid-2022 unless progress is disrupted.
The Fed also indicated that they may begin raising interest rates as soon as 2022 depending on when inflationary pressures subside. Fed chairman Jerome Powell concluded recently that longer and more persistent supply-chain bottlenecks would lead to higher inflation, but raising rates now would be premature.
On October 28, House Democratic leaders delayed the vote on the $1 trillion infrastructure bill again after President Biden unveiled a new framework for a separate, larger social spending and climate package. Democrats want to approve the new bill before voting on the infrastructure bill. Meanwhile, party leaders approved a short-term extension of highway funding pending approval of the larger infrastructure bill.
On October 28, European Central Bank (“ECB”) President Christine Lagarde announced that although inflation may remain high for longer, an interest rate hike is not expected soon. The ECB kept interest rates and monetary policy unchanged. Earlier in September, the ECB slowed the pace of asset purchases under the pandemic purchase program as consumer prices surged. Inflation in the euro zone reached a 13-year high of 3.4% in September while the inflation target and interest rates were 2% and -0.5%, respectively. ECB president Christine Lagarde indicated that easy monetary policy will be maintained for the foreseeable future with inflation forecasts of 2.2% in 2021, 1.7% in 2022 and 1.5% in 2023.
President Biden’s $1.85 trillion spending framework
President Biden unveiled a $1.85 trillion social spending and climate legislation framework, including funding for universal pre-kindergarten, renewable energy tax credits, an expansion of the Affordable Care Act, and tax increases on companies and wealthy individuals. This budget proposal still needs the support of Democrats in Congress.
The budget framework would extend and increase Affordable Care Act subsidies through 2025 and help provide healthcare coverage for the uninsured.
The budget framework allocates $555 billion to climate-related spending, including $320 billion in 10-year expanded tax credits for utility-scale and residential renewable energy, transmission, electric vehicles, and clean-energy manufacturing.
The framework features federally funded preschool for all three- and four-year–olds in the US for six years and a one-year extension of the child tax credit.
Macro Indicators
US job growth slows sharply amid labor shortage
The US labor market continued to recover but job growth fell to the slowest pace of the year in September as the Delta variant and a tight labor supply weighed on economic recovery. Unemployment fell to 4.8% in September from 5.2% in August despite the slowdown in hiring as the labor force participation rate edged lower. Non-farm payroll rose by 194,000 in September, the smallest monthly gain since December 2020, impacted by a 123,000 decline in government payrolls. Despite slower jobs growth, labor shortages are raising wages as employers try to address the tight supply. Weekly initial unemployment benefit claims fell below 300,000 in October for the first since the onset of the pandemic to 281,000 in the week ending October 23. Euro area unemployment dropped slightly to 7.5% in August from 7.6% in July, continuing its downward trend as easing pandemic-related restrictions drove economic recovery into the summer.
Labor shortages and supply chain constraints slow growth
Q3 2021 annualized US GDP slowed to 2.0% after growing 6.6% in Q2 2021, the slowest growth since the end of 2020, following months of supply chain issues, a decline in consumer spending, and the Delta variant surge. The increase in consumer spending, which makes up ~70% of the US economy, dropped to 1.6% in Q3 from 12% in Q2 as disposable personal income fell 0.7% and the personal savings rate declined to 8.9% from 10.5%. The record growth in the first half of the year was helped by government stimulus, business re-openings, and rising vaccination rates which eased in Q3. Stronger consumer demand and an easing pandemic should boost growth in Q4.
Despite rising prices, US retail sales rose 0.7% in September as consumers returned to the office and schools reopened.
U.S. seasonally adjusted annual home sales rose 7% in September to 6.29 million. Strong demand continues, but the gain may be due to a brief drop in mortgage interest rates in August.
GDP in the eurozone grew at a seasonally adjusted annualized rate of 9.1% in Q3 2021, the fastest pace in a year. The eurozone economy grew faster than the US and China in Q3, fueled by easing COVID restrictions and widespread vaccinations, but output remains below pre-pandemic levels, unlike the US and China. Economic growth in the eurozone is expected to slow due to supply-chain bottlenecks and rising inflation.
The US Consumer Price Index (CPI) increased 5.4% year on year (YoY) in September, in line with June and July and slightly above August, remaining at its highest in over a decade. Core CPI, which excludes food and energy, climbed 4.0% YoY in September, driven by strong consumer demand and labor and supply shortages. CPI in the euro area increased 4.1% YoY in October (from 3.4% in September) according to preliminary Eurostat data, to a 13-year high, surpassing the 2% target of the ECB, while core inflation increased 2.1%, driven by surging energy prices.
The IHS Markit Manufacturing Purchasing Managers’ Index (PMI) fell to 58.4 in October from 60.7 in September in the US, and to 58.5 from 58.6 in the Euro area. Production slowed this month, due mainly to supply shortages and transportation delays.
Sovereign bond yields react to Fed signals but remain low
10-year US Treasury yields rose to 1.7% on October 21 after the latest jobs report showed a tightening labor market, indicating a recovering economy and earlier tapering. Yields closed October at 1.56% amid a volatile week with mixed corporate earnings, conflicting economic readings, and the approaching November Fed meeting. 10-year inflation expectations, measured by Treasury Inflation Protected Securities, peaked at 2.69% in October to a more than 15-year high. Germany’s 10-year bund yields rose to -0.08% ahead of US inflation data and hawkish signs from the Fed.
Financial Markets
Equity markets rally despite mixed earnings
US equities closed their strongest month since November 2020, as investors remain encouraged by the earnings season despite negative reports from Apple and Amazon. The S&P 500 and Nasdaq Composite rose 6.9% and 7.3% in October, respectively, while the Dow rose 5.8%, its best monthly gain since March.
The STOXX Europe 600 rose 4.6% to a seven-month high in October, while the UK FTSE100 rose 2.1% amid strong earnings and interest hike expectations. Asian equities were mixed, with the Chinese SSE Composite Index and the Japanese Nikkei 225 Index falling 0.6% and 1.9%, respectively, while the Hong Kong Hang Seng index rose 3.3%.
Credit spreads continue tightening
Investment grade spreads tightened to 0.89% at the end of October from 0.87% in September as investors took advantage of the accommodative Fed policy and low-rate environment before it changes, while high-yield spreads ended at 3.08% from 3.13% in September. First-lien and second-lien spreads to maturity widened to LIBOR + 4.20% from LIBOR + 4.06% and LIBOR + 7.22% from LIBOR + 7.14%, respectively.
Oil prices reach multi-year highs amid tight supply
Spot WTI and Brent crude oil prices rose from $75.03 and $78.31 per barrel, respectively, in September to $83.57 and $83.72 at the end of October. Both benchmarks have climbed approximately 20% since the start of September, with WTI and Brent reaching their highest since October 2014 and October 2018, respectively, fueled by tight global supply and strengthening fuel demand worldwide. Fuel switching to diesel and fuel oil also supported oil prices amid worries over coal and gas shortages in China, India, and Europe.
OPEC+ agreed to maintain its plan to raise daily production by 400,000 barrels monthly until the end of 2022, which may continue to pressure prices as demand increases. OPEC+ reconfirmed their production plan despite pressure from the US and India to increase supply.
US dollar rises, gold falls, and Bitcoin rallies
The US dollar rose to a more than one-year high of 94.52 against a basket of currencies on October 12 amid inflation concerns and expectations that the Fed will announce a tapering. The dollar closed October at 94.12, down slightly from 94.34 in September. Meanwhile, gold prices fell to a one-week low of $1,782 per ounce on October 28 following a stronger dollar and rising US bond yields. By month-end, gold rose 1.5% to $1,784 per ounce. Bitcoin rallied almost 40% in October to a record $66,975, reaching a record close at $60,599.
Earnings
Tech earnings mixed; Amazon and Apple miss estimates
Apple Q3 revenues increased 29% YoY to $83.36 billion but were 2% below estimates, while earnings per share (EPS) of $1.24 were in-line with estimates. The revenue miss was due to larger-than-expected supply constraints driven by an industry-wide chip shortage and COVID-related manufacturing disruptions. iPhone sales rose 47% YoY and iPad and Mac sales grew 21% and 2%, respectively. Apple CEO Tim Cook said that stronger YoY revenue growth is expected in Q4 despite supply constraints possibly worsening.
Amazon revenues grew 15% YoY in Q3 to $110.8, from 37% growth a year ago while EPS was $6.12, 46% and 1% below estimates, respectively. Sales growth slowed as consumers returned to physical stores while supply chain issues persisted. Amazon CFO Brian Olsavsky expects additional costs of $1 billion Q4 due to labor shortages, higher wages, increased shipping costs and global supply chain constraints. Andy Jassy replaced Jeff Bezos as CEO in July.
Facebook shares rose as earnings beat quarterly estimates while revenues missed. Sales grew 35% YoY, 2% below estimates, to $29 billion, while EPS of $3.22 were above the consensus estimates of $3.19. CFO David Wehner said the iOS changes were the largest headwinds in Q3, hurting the ability to target ads to users. Focus will start to shift to its full-screen video Reels feature in the next years.
Alphabet revenue of $65.12 billion in Q3 was 3% above consensus estimates, while EPS of $27.99 were 19% above estimates. Advertising revenue rose 43% YoY. YouTube revenues increased 43% YoY to $7.2 billion. Alphabet CFO, Ruth Porat, said that the new privacy features in iOS 14 earlier this year had a modest impact on YouTube revenues.
Microsoft revenues of $45.32 billion were 3% below estimates and EPS of $2.27 were 10% above estimates. Azure cloud revenues grew 50%. Productivity and Business Processes, which includes Office products and LinkedIn, grew 22%.
Tesla net income of $1.6 billion in Q3 surpassed $1 billion for a second time. EPS of $1.86 were 17% above consensus estimates of $1.59 per share and revenue of $13.76 billion was 1% above estimates, as gross profit margins improved to 30.5% in the automotive business and 26.6% on its overall business.
Financials deliver strong earnings, signaling recovery
JP Morgan and Citi EPS beat consensus estimates by 25% and 30%, respectively. The Q3 results of JP Morgan exceeded expectations on a $1.5 billion boost from lower-than-expected loan losses. Citi reported stronger-than-expected results as trading revenue increased profits significantly. JP Morgan revenues of $30.4 billion exceeded the $29.8 billion forecast, while Citi revenues of $17.15 billion exceeded the $16.97 billion forecast.
The EPS of Morgan Stanley and Goldman Sachs exceeded estimates by 18% and 47%, respectively, amid strong trading, investment banking and asset management results. Goldman revenues of $13.61 billion exceeded the expected $11,68 billion, driven by a rise in completed mergers, debt and equity underwriting. Morgan Stanley revenues of $14.75 billion beat estimates of $14.0 billion, also driven by investment banking activity and $135 billion in added assets in wealth management.
The performance of Visa, Mastercard and American Express was stronger than expected, confirming the economic recovery. Visa revenues of $6.6 billion were above the expected $6.5 billion while the EPS of $1.65 exceeded the expected $1.56. Mastercard revenues of $5.0 billion also exceeded the expected $4,95 billion while the EPS of $2.37 was above the Wall Street estimate of $2.19. American Express revenues of $10.9 billion exceeded analyst expectations of $10,52 billion while the EPS of $2.27 was well above the expected $1.80.
Energy and Industrials rebound
Large energy companies, such as Exxon and Chevron, reported profits for a second consecutive quarter with higher oil prices, increased operating efficiency and enhanced cost control. Both companies remain cautious over capital spending and cost reduction.
The revenues of Caterpillar, often considered a barometer for the economic cycle, of $12.4 billion were slightly below the estimated $12.48 billion with the EPS of $2.66 exceeding average analyst estimates of $2.20.
Sentiment
Consumer sentiment falls amid inflation fears
The Consumer Sentiment Index of the University of Michigan fell to 71.1 in October from 72.8 in September, remaining near pandemic lows amid concerns over higher inflation and changes in economic policies.
The VIX index fell to its lowest level since the start of the pandemic, closing at 16.26 in October from 23.14 in July.
The month-end Fear and Greed Index (which uses seven factors including market momentum, safe-haven demand, and junk bond demand) showed “extreme greed” at 75 as investors rotated into stocks from the relative safety of bonds.
COVID-19
The number of COVID-19 cases and deaths are increasing worldwide but at a slower pace.
US COVID-19 cases have fallen to half the most recent peak in September with average daily cases of 72,000 during the last week of October. 58% of Americans are fully vaccinated although vaccination rates are rising more slowly than when the first shots were given. The US Centers for Disease Control and Prevention recommended additional vaccine booster shots for fully vaccinated people. Hospitalizations decreased by half since the peak to a seven-day average of 103,000 cases in September.
In Europe, only a few countries were spared the high rise in cases from the fourth wave of the pandemic. Most countries that relaxed social-distancing restrictions during the summer are considering measures to prevent increasing cases. During the last week of September, 57% of the 3 million cases worldwide were in Europe. However, traveling within the European Union has become easier as the digital COVID certificate is widely accepted.
Southeast Asia had a major drop in COVID-19 cases which helped pave the way for recovery as easing restrictions on factories help decrease the global supply delays, but it may still can take weeks or months for full recovery of the factories. Demand for semiconductors remains high and supply continues to be tight. Indonesia, one of the hardest hit countries, is still struggling to recover, asking developed countries to increase support for poorer countries. Thailand and Australia have eased international travel restrictions with no quarantine needed after arrival.
The Month Ahead
1. Global vaccine rollout and booster shots
2. President Biden’s $1.85 trillion spending plan and infrastructure bill
3. Policy changes in the US and Europe
4. Delta COVID-19 Variant
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