Nov 15

Stocks and Bonds Rise as Traders Bet on the Fed's Rate Hike Cycle Being Over

Professional traders entered November believing that Jerome Powell's campaign to tame inflation was far from over, but now they are forced to make risky bets that the battle is done.

Firstly, it was Federal Reserve Chair Powell's dovish position on November 1, acknowledging that forecasts regarding future interest rate hikes were not set in stone.

Secondly, the unexpected drop in consumer price growth on Tuesday fueled the largest three-week rally of the year, judging by the combined increase in a pair of popular ETFs tracking U.S. stocks and long-term Treasuries.

According to Goldman Sachs Group Inc., over the past week, fast-money analysts bought about $100 billion worth of global stocks and bonds, and they may need to continue buying.

While the deceleration of inflation was a balm for bearish professionals, their initial shift towards a more bullish position raises concerns in an economy that demonstrated resilience, or what Powell termed "fake data."

However, the conviction that the aggressive turn by the Fed is over sparked a significant bond rally on Tuesday, with the yield on five-year bonds dropping more than 20 basis points to around 4.4%. However, stock investors note signs of economic cooling—a result that puts the 17% gain in the S&P 500 index this year on shaky ground.
"A change in narrative leads to financial markets swinging to opposite extremes that significantly exceed actual changes in fundamental indicators," said Dan Suzuki, deputy director of investment at Richard Bernstein Advisors. "It probably makes sense to smooth out the extremes unless there is a significant shift."
The S&P 500 index jumped 1.9% on Tuesday, showing its best day since April, and an exchange-traded fund tracking long-term Treasuries rose over 2%. Data showed that consumer prices were rising slower than expected, a crucial milestone in the central bank's fight against inflation.

Speculation that the release lays the groundwork for a soft landing may become the basis for growth, but the easing of bearish positions adds fuel to the fire.

According to the Commodity Futures Trading Commission, as of October, active equity managers had a defensive position, while net short bets on Treasury bonds by professional speculators hovered near the highest level in history.

"In November, one of the largest demands for stocks and bonds was observed," said Scott Rubner, managing director at Goldman Sachs. "We model further demand from systematic, corporate, and discretionary hedge funds until the end of the month. There was a significant change in tone today, and sentiments are now leaning towards a year-end rally."

According to Goldman, commodity trading advisors, holding long and short positions in the futures market, made a record short bet on bonds over the last week and may buy around $91 billion next week if the growth continues this month.

Goldman believes this cohort also has the potential to add up to $430 billion if the steps continue over the next month. Meanwhile, CTAs may become buyers of an additional $100 billion in global stocks next week and $212 billion next month if the upward trend persists.

At the same time, of the two major cash-like ETFs, the largest outflow occurred last week since November 2022, as investors withdrew nearly $3 billion—another sign that some capital managers may be ready to invest.

Sentiment fully manifested on Tuesday: a popular junk bond ETF rose, and the Russell 2000 small-cap stock index added more than 5%.

According to Max Kettner, chief multi-asset strategist at HSBC Holdings Plc, among large investors, there is still enough buying power to support a rally in risk assets.
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