Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: US equities ripped higher yesterday, first on a very weak first estimate of Q2 GDP that saw the market pushing Fed rate hike expectations lower still for the cycle after the Fed declared data dependent policy guidance this Wednesday. The rally accelerated steeply after the close on strong results from mega-caps Amazon and Apple and the move held well overnight despite a rather dour mood in Asia, in Japan as the JPY is rallying hard on lower global bond yields.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I). US equities rallied again yesterday as a weak first estimate of GDP saw the market taking Fed expectation to new lows for the cycle after the Fed declared itself data dependent at this week’s FOMC meeting. The action accelerated higher after the close on strong results from Amazon and Apple (more below). The action has taken the Nasdaq to the cusp of a pivotal resistance area near 13,000 and the S&P 500 is threatening its 100-day moving average for the first time since April near 4,125, with larger resistance near 4,200.
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I) Both indices fell with the Hang Seng Index 2.4% lower and CSI300 down 1.4%. Hang Seng TECH (HSTECH.I) lost 4.8% with Alibaba (09988:xhkg), leading the charge lower and falling over 6%. According to the Wall Street Journal, Alibaba’s Jack Ma intends to “relinquish control of Ant Group” after over a year “of extraordinary pressure from Chinese regulators”. Other Chinese mega tech names were down 3% to 9%.
USD pairs: more downside for the US dollar or data whipsawing? As the Fed made it clear that incoming data is in the driver’s seat in determining next steps, yesterday’s weak GDP print saw the USD moving sharply lower. It’s all fairly straightforward, but what would the market if important data next week, including the ISM Services on Wednesday and Friday’s jobs report, don’t provide a consistent drumbeat of negativity on the economy? The largest move among USD pairs has been in USDJPY, as the JPY adjusts to the sharply lower US treasury yields. In other major USD pairs, watching the recent cycle highs in EURUSD of 1.0275 and in the 0.7000 area in AUDUSD for signs of broadening USD weakness.
USDJPY and EURJPY: downside pressure on yield drop. USDJPY broke below the key 135 level overnight as the US recession concerns following the Q2 GDP release led to a further softening in yields, boosting the yen. Pair now eyes support at 131.50 area, but even a higher-than-expected Tokyo inflation is unlikely to push Bank of Japan into the tightening mode. The lower EU yields have also sparked a move lower in EURJPY to 136.50, with the 133 area now in focus as we approach Europe’s growth and inflation prints due later today.
Crude oil prices gain on risk-on and supply concerns. (OILUKSEP22 & OILUSSEP22). Crude oil prices were higher again in the Asian morning after dropping yesterday in the wake the negative Q2 US GDP print showing that the US has slipped. Weaker demand concerns are battling with possibly even weaker supply issues of late. Shell CEO Ben van Beurden warned that there is more upside than downside when it comes to the oil price, with supply remaining tight.
US Treasuries (IEF, TLT). US yields plunged all along the survey on the release of the first estimate of US Q2 GDP(more below), with the 10-year yield benchmark plunging through the key 2.70% area that had held back prices since late April. The 2-10 yield curve has steepened some 15 basis points (to about –17bps from the lows) since the Friday FOMC meeting. Today sees the release of June PCE inflation and the data, from the ISM surveys next week and the US jobs next Friday’s, will play an important role in how much lower yields can go despite inflation registering over 9% for the most recent CPI report and an annualized 8.7% in yesterday’s first estimate of the Q2 GDP Price Index.
What is going on?
Amazon and Apple reported better than expected results after hours. Amazon (AMZN) rose 13% after revenue topped estimates and the e-commerce giant gave a strong sales forecast for the current quarter. Apple (AAPL) rose 4% after third-quarter results narrowly beat Wall expectations; easing concerns supply chain snags and a weaker demand out of China. The company also guided for a strong quarter ahead, with new iPhone models slated for release in September.
US Q2 GDP growth turns negative, PCE data ahead. US reported a second consecutive quarter of negative GDP growth (-0.9% annualized from prior quarter), suggesting the onset of a technical recession. Median expectations were for a slightly positive print. Still, a broad-based recession remains elusive with personal consumption, the largest contributor to US GDP, coming in at +1% and the labour market still very strong. Initial jobless claims for the week were in at 256k vs the cycle high of 261k previously, with the 4-week average still significantly below levels that could spark concerns. The Fed’s preferred measure of inflation, (core) PCE data is due later today, and will form one of the many inputs to the data-dependent Fed’s September decision.
U.S. President Biden and China’s President Xi dug into their positions over Taiwan. Over a meeting that lasted for more than two hours on Thursday, President Biden told President X that “the United States policy has not changed and the United States strongly opposes unilateral efforts to change the status quo or undermine peace and stability across the Taiwan Strait.” President Xi mentioned to President Biden that adherence to “the principle of one China” is the foundation of Sino-American relationship and “anyone who plays with fire will perish by it”. Xi also reiterates China’s committed resistance to “interference by external forces” over Taiwan. It is reported that the two leaders had discussed a possible summit but no agreed plans yet for such a meeting. In the meantime, U.S. House Speaker Nancy Pelosi is scheduled to depart for a trip to Asia but it is unclear if she will go to Taiwan during the trip.
China’s politburo meeting made new emphases on ensuring stability of the property market. The politburo of the ruling Chinese Communist Party of China held a meeting on Thursday. In the readout from the meeting, the politburo made news emphases on ensuring stability of the property market. While it reiterates the official line of “housing is for living in, not for speculating”, wordings seen the first time include “stabilizing the property market”, “utilizing well and in full the policy toolkits in accordance with the local conditions in each city”, “making it the responsibility of the local governments to ensure delivery of apartments and stabilization of people’s livelihood”. The readout further highlights the determination to ensure the stability of the financial market and to properly deal with the risks facing by local and rural banks. The politburo also notes that the authorities will complete reforms and regulate the platform economy under a persistent regulatory framework and roll out a series of “green light” investment projects. The readout has no mention of any growth target for the year.
Japan’s Tokyo inflation higher than expected. Japan’s Tokyo CPI came in above expectations at 2.5% y/y for July (vs. 2.4% expected and 2.3% prior) suggesting price pressures continue to ramp up. It is a signal that national CPI will likely also inch higher for the month, but pressure on the Bank of Japan to join the global tightening race has eased with yields softening. BOJ’s Summary of Opinions from the July meeting was released, which without a doubt, continued to suggest that the Bank would not hesitate to ease further to support wage growth.
Weaker than expected result after hours from Intel, Roku and Dexcom. Intel Corp. (INTC) dropped 8%, as the world’s biggest maker of computer processors fell far short of analysts’ second-quarter sales and profit estimates and slashed forecasts for the year. Roku (ROKU) tanked 25% after the video-streaming platform gave a 3rd-quarter revenue forecast that was below analyst consensus. The maker of glucose-monitoring systems, Dexcom Inc. (DXCM) tumbled 17% after 2-quarter profit and sales that missed expectations.
Chips act gets closer to White House approval to being passed into law. The US Senate has passed the “CHIPS and Science Act,” which Biden claims is an answer to improving American supply chains, reducing inflation and becoming less “reliant on foreign countries” for critical technologies. The bill provides $52 billion in subsidies and tax credits to chip manufacturers to expand and or build new semiconductor facilities so the US can be self-sufficient and reduce imports from Asia. Plus there’s $200 billion for research into AI, robotics and quantum computing and other technologies. The bill needs to be passed into law, hopefully before August 8. If passed into law; Intel, Nvidia, Taiwan Semiconductor, even Apple will be lining up for subsidies for Us-based chip production. The US’ wants to take its share of global chip manufacturing to 40%, from where it is now at 12%.
What are we watching next?
Germany’s 2Q GDP growth is out today. This is the first estimate. Expect a contraction. If business activity remains subdued over the summer and energy crisis issues increase, the German economy will likely face a technical recession this year. Germany is facing a perfect storm (supply chain disruptions, inflation across the board which is denting consumption, an energy crisis, lower global demand etc.). In our view, the energy crisis is the number one issue. We increasingly fear that the German government will need to resort to the rationing of electricity this winter. This will push industrial production into a free fall. It would also have a detrimental on the eurozone growth since Germany roughly accounts for 1/3 of the eurozone economy (see Chart of the Week: Tough week for the German economy).
Several French listed companies will release their semi-annual results today. The luxury group Hermès is likely to post another solid performance. This is the fifth largest capitalization of the CAC 40 Index and one of the only large listed companies able to raise prices in order to maintain margins (pricing power). In January 2022, it raised its prices by 3.5 %, for instance. Hermès is in a very comfortable financial position (net cash of 7bn, shareholder’s equity at 9bn etc.). The P/E ratio is quite low, standing around 35 versus 60 when the stock price was close to its record level. Expect the French utility company Engie to post good results as well. Lower volumes in nuclear and hydro energy were certainly offset by higher prices. Finally, it will likely be a tough day for the industrial group Legrand (specializing in electrical infrastructure). The company is unlikely to be able to pass on higher prices to buyers. This means that margins will shrink this year. The share is down 25% YTD. Expect more downside.
Earnings Watch Calendar
Earnings season winding down for the week, but interesting to hear from the US oil majors today and US consumer product giants Procter & Gamble and Colgate-Palmolive.
Friday: Exxon Mobil, Procter & Gamble, Chevron, AbbVie, AstraZeneca, Sony, Colgate-Palmolive, BNP Paribas
Economic calendar highlights for today (times GMT)