US spends more on debt than defense

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• Dollar rebounds against major currencies, as markets expect fewer rate cuts

• US debt interest costs hit $2.4B per day

• ECB cuts again, inflation drops to 1.7%

• Fed and ECB policies diverge

• The S&P 500 and Dow set new record highs again

• Oil plunges as OPEC slashes demand forecasts for third straight month

Let’s dissect

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Markets Snapshot

Macro and Fixed Income Markets

• US: In a positive indication for third-quarter economic growth, U.S. retail sales rose by 0.4% last month, a notable increase from the 0.1% gain observed in August. This September figure slightly exceeded the consensus forecast of a 0.3% rise. Meanwhile, new applications for unemployment benefits surged in the first week of October, partly due to the damage and disruptions caused by Hurricane Helene in several Southeastern states in late September. However, initial jobless claims unexpectedly fell to 241,000 for the week ending October 12, representing a decrease of about 19,000 filings. Yields on medium- and long-term bonds have declined this week, with the 10-y rate falling to 4.08% from 4.10%.

• The US Dollar Index (DXY) has climbed to 103.4, marking its third consecutive winning week. With DXY right at its 200-day moving average , the resilient labor market has reduced the likelihood of deeper rate cuts, pushing the dollar higher. The CME FedWatch now indicates a 90.6% probability of a 25 basis point rate cut at the November 7 FOMC meeting, with less than a 10% chance of rates remaining unchanged. The meeting will take place two days after the U.S. election, which will make the Fed even more vigilant in limiting higher volatility.

• According to the Final Monthly Treasury Statement released last week, the U.S. debt interest-cost burden reached its highest level since the 1990s for the financial year ending in September. The total spent on net interest payments was $882 billion—an average of approximately $2.4 billion per day—equivalent to 3.06% of gross domestic product, the highest ratio since 1996.

• For the first time, the government now spends more on interest payments than the Defense Department spends on military programs. Additionally, interest liabilities accounted for approximately 18% of federal revenues—nearly double the ratio from two years ago. Treasury Secretary Janet Yellen has downplayed concerns about higher interest costs, stating that the key metric for assessing U.S. fiscal sustainability is inflation-adjusted interest payments compared to GDP. While that ratio has increased over the past year, the White House anticipates it stabilizing at around 1.3% over the next decade. In our view, this statement is controversial at best, as it suggests that if inflation rises, the situation improves rather than worsens for her metric.

• EU: The ECB delivered its third rate cut of the year on Thursday, responding to weak private-sector growth and a sharper-than-expected slowdown in eurozone prices. The deposit rate was lowered by 25bps to 3.25%. Although inflation has dropped to 1.7%, officials anticipate it will rise again before stabilizing at the 2% target. A change in their policy statement now suggests that goal might be reached in the first half of next year, rather than by year-end. When discussing the decision, ECB President Christine Lagarde avoided giving specifics on the timing and pace of future rate cuts, despite noting that the risks of lower inflation outweigh potential inflationary pressures. Markets have ramped up expectations for further easing, with investors speculating that quarter-point cuts could continue through April 2025, rather than March as previously predicted. Some traders are even starting to price for a 50 basis-point cut in December.

• The euro fell to a two-month low of $1.087 as the ECB and Fed's monetary policies diverged. The ECB is expected to continue its rate cuts, following 25bps reductions in June, September, and the latest one in October, driven by softening inflation in the Eurozone, now below its 2% target. In contrast, strong U.S. jobs and inflation data have reduced expectations for significant rate cuts from the Fed, intensifying downward pressure on the euro.

• Japan: Japan's core consumer price index (CPI) indicated a slowdown in inflation for September, as anticipated following the reinstatement of electricity and gas subsidies. The core CPI, which excludes fresh food but includes oil products, increased by 2.4% year-on-year, down from 2.8% in August. Additionally, separate data revealed that Japan's exports in September decreased by 1.7% compared to the same month last year, marking the first decline in ten months and reflecting weakened demand from China. Conversely, imports rose by 2.1%, partly due to the effects of a weak yen, which drives up their value.

• UK: Weaker-than-expected UK inflation and a further decline in wage growth seem to pave the way for the Bank of England to reduce borrowing costs once more. The consumer price index increased by 1.7% in the year ending September, marking the lowest rate since April 2021 and falling short of predictions for 1.9%. Services inflation, a key focus for the BoE, slowed to a more than two-year low of 4.9%.

Equity Markets

• US: Both the S&P 500 and NASDAQ increased by over 0.6%, while Dow increased by more than 1%, marking their sixth consecutive week of gains for all three indexes as the market continues to rebound from a notably poor beginning to September. The S&P 500 and Dow set new record highs, while the NASDAQ finished just under 2% away from its all-time high.

• China: Chinese equities climbed as the central bank announced additional support measures—albeit somewhat vague (discussed in the previous edition of this newsletter)—following data that indicated deepening deflationary pressures in the economy. The Shanghai Composite Index rose by 1.36% in local currency terms, while the blue-chip CSI 300 increased by 0.98%. In contrast, the benchmark Hang Seng Index in Hong Kong dropped by 2.11%.

Commodity Markets

• Oil: Brent crude prices fell below $73/barrel on Tuesday as OPEC cut its 2024 and 2025 demand forecasts for the third consecutive month to 900bpd, while the likelihood of Israeli and U.S. strikes on Iranian oil facilities decreased, with Biden seeking to prevent a pre-election spike in oil prices and putting pressure on Netanyahu to limit scale of the retaliatory attack. Interestingly, a noticeable gap of approximately 1 million barrels per day persists between OPEC’s and the IEA’s estimates.

• In 2024, China is predicted to account for only 20% of global oil demand growth, a sharp drop from the 70% it contributed in 2023. The country’s crude imports fell nearly 3% YoY from January to September, driven by rising electric vehicle adoption and sluggish economic growth. Deflationary pressures in China persist, with vague stimulus measures doing little to alleviate concerns.

• Despite a fluid geopolitical environment, there have been no significant disruptions to oil and gas supplies thus far. Markets have adapted, recognizing weak demand, ample supply, and spare capacity, with oil playing a less critical role in the global economy than it once did. If geopolitical tensions escalate dramatically, price spikes are possible. However, the critical issue is not how high prices might go, but how long they would remain elevated.

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Our Further Reading Recommendations

• Saudi Arabia and Iran Become Unlikely Bedfellows (Bloomberg)

• US Interest Burden Hits 28-Year High, Escalating Political Risk (Bloomberg)