The Overnight Report: Yields Rise, Markets Fall

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This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: IAG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

US markets, led by Nasdaq, declined on Wednesday following stronger-than-expected economic data and a back-up in the US 10-year Treasury yield to a level not seen in nineteen years.

After a positive-to-flat day yesterday, the ASX200 futures are pointing to a weak start.

Good Morning,

The Australian market rose slightly, up 7.5 points or 0.09% to 8765.30, led by Materials, up 1.57% and Property Trusts, up 1.31%.

Healthcare and InfoTech lagged.

SPI futures on Thursday morning are pointing towards an early morning retreat in excess of -1%.

For more details and to stay in touch with which companies are reporting are going ex-dividend, check out the FNArena Calendar https://fnarena.com/index.php/financial-news/calendar/

Today’s Big Picture, J.L. Bernstein extract

The AI Spending Lifting Stocks Could Keep The Fed Hiking

AI spending accounts for roughly a fifth of U.S. economic growth this year.

Building data centers means competing for the same workers, power and materials, which can push prices up.

Chicago Fed President Austan Goolsbee says if that overheats the economy, there’s “no ambiguity” about how the Fed responds.

So strong AI news could now lift bond yields along with chip stocks.

A Diesel Export Ban Could Raise Gas Prices

President Trump backed a diesel export ban Tuesday, with diesel at a record above US$6.50 a gallon.

Refiners would cut output by almost -2 million barrels a day, per S&P Global, which means less gasoline too.

Trump himself said gas prices could feel it, and analysts put the hit near 25 cents a gallon.

U.S. diesel futures are flat this morning, so traders aren’t betting on cheaper diesel yet.

Muse Threatens Companies That Profit When Customers Stay Put

Schwab and Allstate fell Tuesday on fears AI agents like Meta’s Muse will move customers to better deals automatically.

For Schwab, the risk is cash parked in low-paying accounts, the easiest money for an agent to move.

To do that, Muse needs your logins, and fewer than 1 in 10 people trust Meta with them, per Oppenheimer.

ANZ Bank, Australian Morning Focus, extract

It was all about the bond market overnight as yields rose sharply.

In turn, that weighed on equities and risk sentiment generally, driving the DXY up sharply.

The US S&P500 was down -0.8%. The EuroStoxx50 and the FTSE100 ended the session down -0.4% and unchanged, respectively.

In bond markets, the yield on the US 10y Treasury bond surged 15bp higher to 5.11%.

In commodity markets, the active WTI oil future was up 2.5% to US$92.77/bbl, while spot gold was down -1.7% to US$4,284/oz.

US: The composite preliminary PMI rose 2.4pts to 58.4. Growth was led by services, which improved 2.2pts to 58.7. Manufacturing rose 3.1pts to 57.0. The composite PMI is up from 50.3 in March.

Euro area: September preliminary PMI data beat expectations, with strong gains evident in France and Germany. The euro area composite index rose 1.1pt to 53.1. The manufacturing index was steady (52.7), but the services index rose sharply from 51.6 to 53.0, challenging market expectations of a pullback to 51.4.

PMI growth in September was broad-based across the region, with France and Germany leading. Employment in manufacturing improved and was stable in services. The survey results are encouraging and imply that euro area growth is resilient despite the re-intensification of geopolitical risks and elevated energy costs.

Impressive: September PMI data impressed for the US and euro area, with growth showing no signs of restraint despite geopolitical uncertainties. US data (as discussed above) highlight the resilience of the economy amid the current AI super-boom and record wealth effects.

Meanwhile, the euro area composite index rose to its highest level in 41 months. As a general observation, the robust growth backdrop in the US and Europe will feed concern at central banks over the potential for future demand-led inflation pressures.

Oil prices may have traded lower in recent sessions, but strong demand – if it proves inflationary – will hold important implications for monetary policy.

We continue to think that sequential interest rate rises from the FOMC are the appropriate way to send a strong signal of its intent to return inflation to target.

Energy prices recovered as optimism faded over the reopening of the Strait of Hormuz, while hawkish comments from Fed officials and a stronger USD weighed on precious and industrial metals.

Macro Talking Points from Benoit Anne, MFS Investment Management, extract

Fed FOMO and FOMU. In the world of central banks, being the last one to act is rarely a good thing, especially when the macro shock appears to be shared across all major markets.

After the Fed had ramped up its tough language against inflation, it was now time to act and join the tightening party that has been spearheaded by the ECB.

From that perspective, the Fear of Missing Out (FOMO) has been addressed. So has the fear of falling behind the curve, at least for now.

However, we may still face another Fed policy challenge: FOMU. The Fear of Messing Up, that is.

For sure, the rate hike can be interpreted as credibility-enhancing, but we believe that there is still plenty of work to do before claiming that policy credibility has been fully restored. In particular, we are in the camp that would argue that the new Fed communication strategy is a major problem to the extent that it promotes greater rate volatility and policy uncertainty.

To be fair, some market participants are less critical as they believe that Kevin Warsh’s tight-lipped approach could create a bit more discipline by market players, whereby more volatility today results in lower term premia tomorrow.

There is also another source of confusion on our radar. If the Fed only raises its policy rate one more time as suggested by the dots, can we call that a proper tightening cycle?

Not hardly. And yet, the current and projected deviation from the official inflation target is such that there may be some policy inconsistency here.

As an inflation-fighting central bank, you certainly do not want to validate the perception that inflation persistently missing its target is becoming tolerated. Simply because this would likely push term premia and long-end yields higher, undermining the very credibility the Fed is trying to restore.

To put it simply, in our view the risk of policy error remains elevated, although admittedly, we are a bit in the dark, compliments of the absence of policy signals. Investors may wish to assess the role of duration carefully in the current environment. 

Why today’s bond backdrop looks different from 2022. 

The last few weeks have understandably felt unsettling for global fixed income investors. Global monetary policy has shifted quickly as central banks confront sticky inflation.

The ECB and Federal Reserve have signaled that further rate hikes may be needed, and futures markets now price roughly three hikes in the US and Europe by mid-next year, with even more expected in the UK, New Zealand and Canada.

For bond investors, that naturally raises memories of 2022, when aggressive tightening drove one of the worst fixed income drawdowns in four decades. But we believe that this time the hiking cycle may prove more manageable.

In 2022, policy rates started near zero and had to rise dramatically to counter inflation above 8% in many economies.

Today, inflation remains above target, but it is far lower than at the peak, and markets are pricing a far less extreme policy response. Bonds can also have more cushion. Yields are meaningfully higher than before, giving fixed income a better ability to absorb rate increases.

The breakeven yield – a measure of how much rates would need to increase before wiping out a year’s worth of total returns – for the Global Aggregate Index was just 18 basis points at the end of 2021; today it is nearly 70 basis points, close to three rate hikes’ worth of protection. Valuations also appear attractive.

With the Global Aggregate Index yielding around 4.25%, history suggests a solid starting point: since 2000, when yields have been within 25 basis points of today’s level, the median five-year annualised return has been 5.56%.

In our view, a milder hiking cycle, higher income cushion and stronger entry point may support the case for staying invested in fixed income (Contribution from David Peterson, Insights Analysis Lead Analyst).

Corporate news in Australia:

• Insurance Australia Group ((IAG)) will appeal the ACCC’s rejection of its proposed $1.4bn acquisition of RAC Insurance
• KMD Brands ((KMD)) is engaging with multiple interested parties over potential takeover proposals after previously rejecting approaches
• IDP Education ((IEL)) rejected a second takeover proposal from Blackstone, valuing the company at around $700m, saying it undervalued the business
• The Global Beauty Group has appointed McGrathNicol to seek a buyer as its founders explore a sale of the Melbourne-based beauty device business
• Digital Realty has emerged as a potential bidder for Stack Infrastructure’s APAC data centre business
• Riverside-backed Altius is acquiring Converge International to expand its workplace wellness platform ahead of a potential sale valued at more than $500m
• Strategic rivals are reportedly considering counter-bids for Reliance Worldwide ((RWC)) following Brookfield’s agreed $3.6bn takeover
• Meeka Metals ((MEK)) is seeking to raise $30m at $0.10 per share amid operational issues

On the calendar today:

-AU Aug Unemployment

-JP Sep PMI prelim

-US 2Q Current A/C

-US Aug Bldg permits final

-US Aug New home sales

-BRISCOE GROUP LIMITED ((BGP)) ex-div 8.09c

-BISALLOY STEEL GROUP LIMITED ((BIS)) ex-div 13.00c (100%)

-PRL GLOBAL LIMITED ((PRG)) ex-div 3.00c (100%)

-SALTER BROTHERS EMERGING COMPANIES LIMITED ((SB2)) ex-div 2.00c (50%)

-WASHINGTON H. SOUL PATTINSON AND COMPANY LIMITED ((SOL)) FY26 earnings report

-SUNCORP GROUP LIMITED ((SUN)) AGM

-WISEWAY GROUP LIMITED ((WWG)) ex-div 0.60c (100%)

FNArena’s four-weekly calendar: https://fnarena.com/index.php/financial-news/calendar/

The Australian share market over the past thirty days…

For more detail go to FNArena’s Australian Broker Call Report, which is updated each morning, Mon-Fri.

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(Readers should note that all commentary, observations, names and calculations are provided for informative and educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views expressed are the author’s and not by association FNArena’s – see disclaimer on the website)

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