Hot start to bonds this morning, up 45 bps.  S&P Futures up .25

Cash bond trading was closed until 8pm ET last night, but global financial markets had already responded to news in the Middle East.  Investors moved into bonds as safe haven as the news of the war was announced. Surging treasury yields in recent market openings have some Fed officials suggesting less need for further rate hikes.

So far, it seems to be having an muted impact on oil prices. While international instability usually causes interest rates to fall, the strong labor market is the biggest factor and will probably remain so, especially after Friday’s big number.

Small Business Optimism slipped in September.  Consumption remains strong as consumers spend on credit, while small business is dealing with a tight labor market.  To manage rising labor, energy, and other costs, they raised prices at record high rates and continue to do so, adding to inflation pressures.

Bonds rallied fairly sharply to start the holiday-shortened week.  The most obvious source of motivation was a flight to safety driven by the Israel-Gaza conflict, but that explanation raises questions due to the stock market also improving (a true flight to safety would see stocks move lower). A slew of friendly Fed comments helps everything make sense.  The Fed increasingly sees the bond market doing more of the heavy lifting on creating tighter financial conditions, thus obviating additional Fed rate hikes.  One could even say that the attacks over the weekend suggest that the Fed err on the side of steady rates vs rising rates at the next meeting (thus providing a way to reconcile both of the competing market motivations).

MBS closed up 58 bps at 98.25

Chinese real estate developer Country Garden defaulted on a HK dollar denominated loan. Sales have collapsed, with the first three quarters of 2023 down 44% from the previous period, and September sales down a whopping 81%. The developer has $187 billion in liabilities.

Some think this is the biggest black swan event in the financial markets. I find it highly unlikely that the world’s second biggest economy could have a Great Depression-esque real estate implosion without any negative credit consequences outside of its country. Western investors and banks will lose money, and that might be the catalyst for the Fed to cry uncle.

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