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Fed to start tightening its monetary policy: October 2021 Monthly Market Commentary

08 November 2021

MARKET CONTEXT: Fed to start tightening its monetary policy  

Global Macro:  As expected, the US Federal Reserve decided to start reducing its monthly bond purchasing program by US$15bn, which should trigger a moderate rise in long-term yields. On the other hand, other major central banks are expected to keep their target rates unchanged till the end of next year: ECB (-0.50%), BoJ (0%), PBoC (2.20%). We note global economic activity has been improving. In the US, the services Purchasing Managers’ Index (PMI) surprised to the upside, reaching a record-high level of 66.7 in October. In China, exports surged 28.1% YoY to US$305.7bn in September. So far, Evergrande’s partial default has been contained by the Chinese regulator and the PBoC and we believe a widespread contagion to other sectors of the economy is unlikely. Strong global demand has been driving commodity prices up, with oil prices rising another 10% in October and 70% in 2021, while natural gas prices doubled in 2021. On the pandemic front, we note the Delta variant has only had a moderate impact on global economic growth, which contributed to improved market sentiment.  

Financial Markets: 

Although the Fed started to tighten its monetary policy, we believe the US is unlikely to let their cost of funding increase much. Based on our econometric model, over the next 12 months, we expect to see the effective Fed funds rate (currently 0.08%) within the [0.10%; 0.50%] range, the 10-year US Treasury yield (currently 1.56%) within [1.4%; 2.0%], the 10-year German Bund yield (currently -0.18%) within [-0.3%; +0.2%], and the 10-year Chinese government bond yield (currently 2.95%) within [2.8%; 3.2%]. Global equities rallied in October, driven by strong earnings and increasing economic activity. Given anticipations of higher US rates, the USD has remained strong against most currencies, except the RMB, which strengthened c.1% in October. The RMB strength is supported by strong exports and interest rates that are much higher than in Western economies (short- and long-term yields close to 3%).


Equity: Month to date the S&P 500, Euro Stoxx 50, and Hang Seng Index gained 6.7%, 5.0%, and 3.3%, respectively, amid improved market sentiment. Fixed Income: The 10-year US yield further rose 4bps in October to 1.56%, underpinned by market anticipations of the Fed’s policy tightening; as a result, Emerging Market government bonds (-0.1% in USD; -1.6% in local currencies) and High-yield corporate bonds (-0.1% in USD; -0.4% in EUR) all went down. Currencies: With respect to USD: EUR -0.1%, AUD +4.3%; CNY +0.8%; safe-haven JPY -2.3%, CHF +2.0%. Commodities: Gold rebounded by 1.5% in September while oil prices further climbed 10.4%, fueled by strong global demand and insufficient supply.