The IMF raised concerns about the accelerating risks of geopolitical conflicts, trade protectionism, and growing deficits.<\/p>\n\n\n\n
The ruling coalition in Japan failed to secure a majority of seats in Japan\u2019s House of Representatives election.<\/p>\n\n\n\n
Federal Reserve districts indicate that the US economy is holding up, although there are areas of weakness, such as manufacturing activity.<\/p>\n\n\n\n
Rising government debt, US election uncertainty and political surprises in Japan have all contributed to a sense of angst in the markets, despite the continuation of positive surprises during earnings season. Here\u2019s what I\u2019m watching closely now.<\/p>\n\n\n\n
Last week, the International Monetary Fund (IMF) lowered its global growth forecast for 2025 while recognizing central banks\u2019 success in tamping down inflation and avoiding recession. The IMF\u2019s concerns about the accelerating risks of geopolitical conflicts, trade protectionism, and growing deficits led to the downward revision. Chief Economist Pierre-Olivier Gourinchas explained, \u201c\u2026downside risks are increasing, and now dominate the outlook.\u201d1<\/a><\/sup><\/p>\n\n\n\n I was in Europe last week meeting with clients, and there was clearly concern about the potential for trade wars if former President Donald Trump were to win the US presidential election. And it\u2019s clear there’s concern about an escalation in geopolitical tensions, especially in the Middle East \u2014 just look at the sigh of relief evidenced in the drop in the price of oil last week when Israel chose not to bomb oil production facilities in Iran.<\/p>\n\n\n\n But it\u2019s more than that. Last week, the IMF also raised concerns about global public debt, which is expected to reach $100 trillion, or 93% of world gross domestic product (GDP), by the end of the year.2<\/a><\/sup> So many countries are facing debt concerns. Take the UK, which is waiting with some trepidation for the release of the Autumn Budget this week. I expect looser fiscal policy, but nothing nearly as loose as the 2022 budget from the Truss government. This government continues to stress that it will be fiscally responsible and has pledged to decrease debt as a percentage of GDP (albeit using a different metric than previous governments). So we might get a mild spike in gilt yields, but I am confident we will not see the type of gilt crisis we saw in 2022. Even if we do, we know government entities stand ready to respond quickly, as they did two years ago.<\/p>\n\n\n\n Last week also saw a surprise upset of the ruling coalition in Japan, which failed to secure a majority of seats in Japan\u2019s House of Representatives election. It was not in my bingo card for this year that Japan\u2019s political situation would look similar to that of France, with Japan\u2019s prime minister trying to form a new ruling coalition, just as Emmanuel Macron did earlier this year.<\/p>\n\n\n\n Coalition building to form a government will take place over the next several days (Japan\u2019s constitution requires that an extraordinary session of the Parliament convenes within 30 days of the election for the House of Representatives to elect a prime minister). There seem to be three possible scenarios for the new government involving different coalition combinations, two of which would enable Japan\u2019s new prime minister, Shigeru Ishiba, to remain in power while one scenario would mean the leader of the opposition party would become the next prime minister.<\/p>\n\n\n\n On the monetary policy front, conventional wisdom suggests that the election defeat for the ruling coalition may slow the policy tightening process by the Bank of Japan (BOJ) \u2014 even more so than Ishiba\u2019s win over Sanae Takaichi last month to lead the Liberal Democratic Party (LDP).<\/p>\n\n\n\n From an economic policy perspective, the new government\u2019s fiscal policy is likely to be more expansionary as the major opposition parties proposed tax cuts and increased spending for low-to-middle income people. This would likely result in greater overall government debt, which could force greater belt-tightening down the road. However, for now, it is expected that the Japanese economy\u2019s structural transformation toward sustained domestic demand growth is likely to be intact, given the continued tightness in Japan\u2019s labor market. This structural shift should continue to support Japan\u2019s equity market.<\/p>\n\n\n\n The Bank of Canada decided to cut rates by 50 basis points last week. This was its fourth consecutive decrease but its first jumbo cut of the cycle. Bank of Canada Governor Tiff Macklem declared, \u201cCanadians can breathe a sigh of relief. It\u2019s a good news story. It\u2019s been a long fight against inflation, but it\u2019s worked, and we\u2019re coming out the other side.\u201d He was clear that the focus is now on supporting demand while maintaining low and stable inflation: \u201cWe need to stick the landing.\u201d3<\/a><\/sup> We could very well get one more rate cut this year from the Bank of Canada as it proceeds with its objectives. It is worth noting that the IMF anticipates a very significant pickup in growth for Canada in 2025, which is not the case for most other major developed economies (where expectations of modest increases are more the norm). It anticipates GDP growth of 1.3% this year, which accelerates to 2.4% next year.4<\/a><\/sup><\/p>\n\n\n\n Also last week, the Federal Reserve Beige Book<\/a> was released. My key takeaways are quite simple:<\/p>\n\n\n\n Some districts are seeing weaker manufacturing activity. Consumer spending is mixed with continued signs of pressure for some consumers, who are buying less expensive alternatives.<\/p>\n\n\n\n It seems that employers continue to place importance on retaining employees, after having difficulty finding them for so long. The good news is that, while the labor market remains relatively tight, a number of districts noted wage growth has slowed.<\/p>\n\n\n\n The most recent Beige Book is littered with references to the uncertainty created by the US presidential election, which is causing businesses to delay major decisions including investment plans and hiring, and also seems to be tamping down consumer spending, especially around major purchases. Even recent manufacturing weakness was blamed, at least partially, on election uncertainty. I was encouraged to see some businesses expect a significant increase in activity in 2025 once election-related uncertainty is resolved and interest rates<\/a> continue to ease; this is a view I have held for a while.<\/p>\n\n\n\n Last week saw continued positive earnings reports. Thus far, 37% of S&P 500 companies have reported earnings. Of those companies, 75% have reported a positive earnings surprise while 59% have reported a positive revenue surprise.5<\/a><\/sup><\/p>\n\n\n\n Some bellwether companies reported earnings last week, most notably UPS. As a shipping company, UPS can give us a sense of the strength of commerce, and last week it reported better earnings and revenue, which further supports the view that the US economy is doing relatively well despite areas of weakness. <\/p>\n\n\n\n Last week, the 10-year US Treasury yield reached its highest level since July. On Sept. 16, right before Fed\u2019s super-sized rate cut, the 10-year US Treasury yield was slightly above 3.6%. At the end of last week, it closed slightly above 4.2%; that is a very significant rise in a relatively short period of time.6<\/a><\/sup><\/p>\n\n\n\n However, rising yields have done little to dampen the stock market rally this year \u2014 until very recently. We did see US stocks fall last week, although this isn\u2019t surprising given that when yields rose quickly in both October 2022 and October 2023, US stocks fell.6<\/a><\/sup> A more modest stock sell-off occurred in April 2024 due to a rise in yields but lasted only briefly. Of course, it\u2019s not just the 10-year US Treasury yield. The 30-year Treasury yield has seen a similar runup, from a bottom of 3.936% on Sept. 16 to a close of 4.47% on Oct. 25.6<\/a><\/sup><\/p>\n\n\n\n Investors may be worried about the prospect of higher US budget deficits in the future, which could be pushing yields higher. That is a common theme among many developed economies, several of which I discussed earlier. Having said that, I must give the caveat that trying to understand what is driving the 10-year US Treasury yield isn\u2019t simple \u2014 many factors impact it, including growth and inflation expectations. But I do suspect that bond vigilantes are at least part of the reason, given neither major US party is focused on fiscal prudence \u2014 and hasn\u2019t even tried to convey a message of fiscal restraint, unlike the current government in the UK.<\/p>\n\n\n\n Maybe it\u2019s no surprise that the AAII Investor Sentiment Indicator has seen a significant change in sentiment in the past month. On Sept. 18, bullish sentiment was 50.8%.7<\/a><\/sup> Since then, bullish sentiment has declined; the most recent reading, reported Oct. 23, show bullish sentiment at 37.7%.7<\/a><\/sup> There’s substantial volatility in these numbers on a week-to-week basis, but the trend is clear. There’s a lot of uncertainty in the air, which lends itself to worry about downside risks \u2014 including tariffs, wars, and government debt.<\/p>\n\n\n\nPolitical surprises bring change to Japan<\/strong><\/h2>\n\n\n\n
Bank of Canada makes its first \u2018jumbo cut\u2019 of this easing cycle<\/strong><\/h2>\n\n\n\n
Takeaways from the Federal Reserve Beige Book<\/strong><\/h2>\n\n\n\n
The US economy is holding up, although there are areas of weakness<\/strong><\/h3>\n\n\n\n
Job growth was very modest but layoffs have also been very modest<\/strong><\/h3>\n\n\n\n
The presidential election has created uncertainty for businesses and consumers<\/strong><\/h3>\n\n\n\n
Learnings from earnings reports<\/strong><\/h2>\n\n\n\n
Markets showed some fear last week<\/strong><\/h2>\n\n\n\n
Looking ahead<\/strong><\/h2>\n\n\n\n