Tech Leads Market Pullback

STOCK INDEX FUTURES

The indexes are down sharply as tech leads a sharp pullback. Palantir shares dropped more than 5% despite solid quarterly results as analysts questioned the stock’s high PE ratio, as growing skepticism appears to be playing out about this year’s tech rally. Focus in the equities will center around AMD’s earnings after the bell, with focus on its massive AI deals. Spotify and SuperMicro are also set to report. Several Wall Street chief executives, including those from Morgan Stanley and Goldman Sachs, warned at a summit in Hong Kong that markets may be due for a significant correction. Talk of a pullback was centered around above-average PE ratios as concerns about high valuations have intensified after global equities repeatedly hit new highs this year despite a slowing US economy and a government shutdown.

Market attention this week will center around ISM services PMI data and ADP private nonfarm payroll figures for any clues on whether the Fed will cut rates next month due to the absence of official government data. Markets will be looking for signs of weakness in the labor market and subsiding inflationary pressures. Yesterday’s manufacturing PMI data showed a further contraction in manufacturing activity in the US alongside weak labor conditions and subsiding prices pressures.

CURRENCY FUTURES

US DOLLAR: The USD stayed near three-month highs as divided Fed speak and a weaker yen supported dollar strength. Money markets are pricing a 68% chance of a December rate cut from the Fed, down sharply from being nearly fully priced in before the Fed’s decision last week. The shift in expectations has supported the dollar. In Fed speak, Governor Miran said he was ready to vote for a 50 bp cut again in December, Chicago Fed President Goolsbee was undecided on another cut, while San Francisco Fed President Daly said she was open to a December rate cut but favors moderately restrictive rates until inflation moves to target. With labor market weakness remaining the key figure in Fed policy, markets will turn their attention to ISM services PMI data, specifically the employment index, and ADP’s private nonfarm payroll data.

EURO: The euro was lower on broad dollar strength as markets in the US await ADP payroll data for clues on the Fed’s trajectory. It is a quiet week of data for the eurozone, leaving currency movements susceptible to moves in the dollar and news out of the US. Final revisions to the services purchasing managers’ index will come Wednesday. German manufacturing orders data for September will also be due on Wednesday, and industrial output figures will be released Thursday alongside eurozone retail sales data. For the ECB, it enjoys a rare period of low inflation and steady growth. The bank has made clear it is in no rush to change policy given that inflation is next to target and that growth is stable. It is unlikely the ECB will move to cut rates anytime soon, especially as downside risks have largely subsided.

BRITISH POUND: The pound headed sharply lower as markets weighed recent comments from Finance Minister Rachel Reeves, where she reiterated her commitment to sticking to her fiscal rules in her November budget, signaling that tax hikes are expected. More importantly, it will give policymakers at the Bank of England an understanding that the government is likely to raise taxes, something it will take into account when it votes on policy Thursday and updates its quarterly monetary policy report. Money markets are pricing in less than a 40% chance that the BoE will cut rates at this meeting, which is up substantially from earlier in the month when markets had not priced in any moves until the spring. A cooler-than-expected inflation reading helped add to bets that the central bank would cut rates earlier than expected, although inflation still remains well above the 2% target at 3.8%. Elsewhere, final PMI data for the services sector will be released on Wednesday.

JAPANESE YEN: The yen was higher after Finance Minister Satsuki Katayama reiterated on Tuesday the government would continue to monitor foreign exchange movements with a high sense of urgency. The yen is approaching levels at which Japanese authorities intervened in markets in 2022 and 2024 to support the currency. Yen weakness is expected to continue unless the Bank of Japan sends signals that it will tighten policy before year-end or if the government signals that it will intervene in markets to support the currency. On the other hand, Prime Minister Sanae Takaichi said Japan has yet to achieve sustainable inflation supported by wage growth, cautioning against further rate hikes as inflation has been driven by higher food prices and not reliable inflationary pressures. The BoJ will release meeting minutes from its September meeting later this evening, where two board members proposed hiking rates to 0.75%. BoJ Governor Kazuo Ueda recently said that he sees no risk of Japan falling behind on the monetary policy side, signaling that the central bank is in no rush to hike rates after it held rates steady last week. Household spending data, which could offer leading clues on inflation, will be released Friday.

AUSTRALIAN DOLLAR: The Aussie was sharply lower despite the Reserve Bank of Australia holding rates steady and signaling that any more policy easing will be on hold, as it cited higher inflationary pressures in the economy. The RBA also revised its forecasts for inflation sharply higher and does not see core inflation returning back to its 2%-3% target until mid-2026. The RBA expects trimmed mean inflation to reach 3.2% by the end of the year, up from the current 3%, a sharp upward revision from the previous forecast of 2.6%. Headline inflation, which ran at 3.2% in the September quarter, is now seen peaking at 3.7% by mid next year in part due to the expiration of government electricity rebates. The RBA also expects the labor market to remain steady, projecting the unemployment rate to remain at 4.4% over the coming years after recently ticking higher to 4.5%. Money markets are now only placing a 10% chance of a cut in December from the RBA, signaling that its easing cycle may be over as inflationary pressures in the economy begin to materialize.

INTEREST RATE MARKET FUTURES

Yields are lower across the curve as markets await Wednesday’s Treasury quarterly refunding announcement and ADP payroll data. The Treasury is expected to maintain auction sizes for the seventh consecutive quarter, reinforcing expectations of stable issuance. Meanwhile, US repo futures continue to reflect elevated overnight funding rate expectations, with today’s overnight rate opening above 4.00%. However, yesterday’s close below 4.00% suggests excess cash remains in the system, contributing to softer funding conditions.

Yesterday’s ISM manufacturing PMI data showed price pressures lowered slightly, with the prices index hitting its lowest level since January after having fallen for the last four months. Fed speak has been mixed; Chicago Fed President Goolsbee said he remains more concerned about inflation than employment, while Governor Cook pointed to rising risks of labor-market weakness. San Francisco Fed President Daly urged officials to “keep an open mind,” and Governor Miran emphasized that policy remains restrictive. Markets are now implying a 68% chance of a Fed cut in December. On top of comments from other officials yesterday, a growing divide among policy members regarding how to proceed in December is apparent. Paired with an absence of data and inflation that is still resting well above the Fed’s target, there is likely to be strong resistance to continuing to lower rates.

The spread between the two- and 10-year yields rose to 51.50 bps from 50.50 bps on Monday, while the 2-year yield, which reflects interest rate expectations, moved lower to 3.580%.

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