The Week Ahead

At the start of the new week the bond market is on fire. French yields are rising across the curve and bond prices are sliding, after the new Prime Minister  Sebastian Lecornu resigned this morning after his new cabinet faced scrutiny and criticism. The French bond market is reflecting the uncertainty that this presents, will it lead to new elections? Could President Macron reign? The leader of the French Socialists who hold a swing vote in the French parliament has said that Macron’s ‘group’ is imploding and has no legitimacy left.

Markets digest latest French political risks

This is a fast-moving situation, but once again, France is rudderless politically speaking, and this is also weighing on the stock market. The Cac 40 index is down 1.77%, it is underperforming other European indices. The biggest decliners include the luxury sector, such as Hermes and LVMH. While the political situation may not directly impact these companies, the fact that France’s largest and most prestigious companies are getting sold off today is a sign that investors are offloading French assets on a broad basis, and the risk is that this causes contagion elsewhere. At the back of everyone’s mind, is whether this latest political stumbling block in France is a step closer to National Rally, the far-right party, to take power. Pricing in the risk of this happening is tricky and could cause volatility down the line. It is also why the French- German bond spread is at its highest level for months and is inching towards 100bps.

Japan’s dovish new PM sends bond yields soaring

Political risks are surging around the world. The US Federal government is still  shutdown, the UK government has record low approval ratings, and Japan has just announced a new leader. The announcement that Sanae Takaichi will likely become the next Japanese PM has sent stocks in Japan soaring and bonds and the yen tumbling.

The new PM is pro stimulus, and she has said that the Bank of Japan should not raise interest rates, which is feeding demand for stocks and weighing on long term bond yields. USD/JPY is down 1.8% today and is back above 150.00. It is by far the weakest currency in the G10 FX space, as the FX market prices in Takaichi’s policies’. The decline in the yen is also a sign that the market is pricing out the prospect of BOJ rate hikes this year.

The 30-year Japanese bond yield is at its highest ever level, as long end bond yields soar in Japan. This does not mean that Japan is having its own ‘Liz Truss’ moment, 30-year yields are still only 3.3%, however, it does highlight how politics are dominating bond markets this year.

G7 political turmoil plays out in the bond market and could be a driver of volatility

This is something to watch, two G7 countries have seen their long end bond yields soar today: Japan’s 30-year yield is higher by 13bps, the French 30-year is higher by 6.5 bps. This is having a global impact, and the bond market is a sea of red this morning, as bond prices fall and yields rise around the world.  The bond market is central to the global financial system, so this could cause volatility at the start of this week. European stocks are falling this morning, although US equity futures are pointing higher, suggesting that the US is acting as a safe haven this morning, as investors rotate out of European, particularly French, assets into the ‘safety’ of the US.

The euro is not unscathed by the French political drama, and the single currency is the second weakest currency this morning behind the yen, and EUR/USD is lower by 0.7%. Unsurprisingly, in response to the political turmoil, the gold price is surging and has made a fresh record high already today. The yellow metal is higher by $60 and is within touching distance of the key $4,000 per ounce level.

 Pharma and consumer stocks in focus at the start of Q4

Global equity markets closed higher last week, the S&P 500 rose by just over 1%, the Nasdaq rose by 1.3%. However, European indices were the top performers, the Eurostoxx 50 index rose by 2.7% and the FTSE 100 was higher by 2.2%. However, this may not last long as the French political risks could see the US overtake Europe this week.

The FTSE 100 was driven higher by gains for pharma stocks, including AstraZeneca and Hikma Pharmaceuticals. JD Sports was the top performer, rising by more than 16% on the week, lifted by Nike’s stronger than expected results, which could be a turning point for the consumer discretionary/ lifestyle sector.

Similar themes drove European markets, Sanofi, the biopharma company, was the top performer on the Eurostoxx index, rising by 10%. LVMH was also a top 10 performer, rising by more than 7%, as the consumer discretionary sector received a boost from Nike’s results However, LVMH’s crown has slipped this morning and it is one of the weakest performers in Europe on Monday.

Pharma has had a strong start to Q4, which could see this sector play catch up in the final quarter of the year. Pfizer’s deal with Trump to reduce drug prices in America, in return for a multi-year reprieve from tariffs, set the healthcare sector on fire last week. If political risks continue to linger, the healthcare’s defensive qualities could also keep this sector buoyant this quarter.

Have equity markets peaked?

The FTSE 100, the Eurostoxx 50, the S&P 500 and the Nasdaq all closed at record highs at the end of last week. Sector rotation could be a theme to watch out for this quarter. Healthcare stocks have lagged other sectors like tech in recent months, and while the valuations of many stocks looks historically stretched to the upside due to the strong run for equities in the last 2 years, AstraZeneca’s price to earnings ratio of 30 could still attract buyers as we move through October.

What the Electronic Arts deal means for tech stocks

The other themes for equities this week included the deal for Electronic Arts to go private in a massive $55bn mega deal, backed by the Saudi Public Investment Fund. This suggests that Saudi Arabia could become a bigger force in the gaming and tech sector through its investment fund. Interestingly, although Electronic Arts will now de-list from the US exchange, the Nasdaq also reached a record high last week. Valuations of other targets could start to rise in anticipation of more mega deals for the tech and AI sector to come.

Bitcoin could stay elevated as political risks remain high

The US government shutdown may be brushed off by equity markets, but the surge in bitcoin  to a record high on Sunday, it passed $125,000 for the first time, is a sign that crypto is getting a boost from the political turmoil in the US, and it may continue rallying for the duration of the shutdown.  This is the highest level since mid-August, and Bitcoin is rising in line with global equities and gold,

Below we take a look at the key events in the coming days.

1, FOMC meeting minutes

Financial markets seem very happy to dismiss the US government shut down that started on October 1^st and shows no sign of ending. The main impact for financial markets is the delay to official government economic data like the Non-Farm payrolls report. If the shutdown continues, then the CPI data, that is schedule for release on 15^th October, may also be delayed. This could have big ramifications for the next FOMC meeting on 28-29^th October, and the Fed may be flying blind when trying to set policy in the coming weeks.

The lack of economic data makes Fed speak and the minutes from the September FOMC meeting even more important than usual. There are 10 FOMC members who are scheduled to speak this week. The minutes could also sound a little more hawkish than the market expected, especially after a raft of Fed speakers voiced concerns over the pace of inflation in recent days and weeks. The split at the Fed is becoming noticeable, and could become a risk factor for equities in the coming weeks.

Thus, the Fed minutes may suggest that Fed members are concerned about inflation. While this could weigh on stocks, the shutdown could force the Fed to cut rates. The Fed Fund Futures market has priced in a 96% chance of an October cut to 3.75% -4%. Thus, even though the minutes may suggest that the prospect of rate cuts is nuanced, we think that the Fed will cut rates at both the October and the December meetings. This could lead to US Treasury outperformance compared to other global bonds this week, and it may boost US equities.

2, ECB meeting minutes

The minutes from the last ECB meeting are also scheduled for release this week. Investors will be watching to assess the potential for another rate cut from the ECB. Consensus is building that the ECB could have ended their rate cutting cycle, and the recent uptick in inflation across the block has reinforced this view. The ECB said in their statement last month that risks to growth were more balanced after clarification about the trade agreement with the US. Thus, we do not think that this week’s minutes will suggest that further cuts are likely. This has been reinforced by a more neutral stance from ECB speakers in recent weeks. Overall, the minutes could lead to support for the euro, which was one of the weaker performers in the G10 FX space last week, but still managed to rise by just over 0.1% vs. the USD. French political risks has caused the euro to start the week on the backfoot, and this could persist if the French crisis grows in the coming days.

3, The start of earnings season

Q3 earnings season will kick off this week with the bulk of S&P 500 members reporting earnings between now and the end of October. Forecasts suggest that US earnings growth could slow to 6% in Q3, down from 11% in Q2, however, some expect earnings to beat pessimistic forecasts for another quarter. Tesla reports results at the end of October, and it could report better than expected earnings reports after it reported a record quarter for deliveries in Q3. There is also growing expectation of upside-surprises for the Magnificent 7.

However, there are two risks for this earnings season. Firstly, the FX impact. The weakness of the dollar could add a currency headwind to some earnings, which may hit the FTSE 100 in the coming weeks, as companies who earn in dollars get hit by a stronger pound.  

The second risk is tariffs, which hang over this earnings season an investors will be looking to see how corporate results are impacted by the $93bn of customs duties collected by the US authorities last quarter, which was higher by 33% compared to Q2. This could act as a drag on profit growth for US and global companies last quarter.

AI and the Magnificent 7 will also be in focus. Capex spending will be scrutinized especially from the hyperscalers. Capex is expected to rise 75% YoY this quarter, but then it is forecast to slow sharply in Q4. Thus, the focus will be on what the hyperscalers like Microsoft, Google, Meta etc say about their future capex spending intentions. This could have a big impact on semiconductor stocks like Nvidia. Typically they have exceeded expectations, so the future of the AI trade may depend on hyperscalers’ continuing to spend big on AI infrastructure.

This week, Delta will kick off earnings season along with Pepsi on Thursday. These results will be watched to see what they say about the strength of the US consumer. A stronger set of results from these two companies could boost the equity market rally, which has gained strength after better-than-expected Q2 results.