Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: The global macro environment took another beating late last week with disappointing Eurozone PMIs and a UK mini-budget causing a havoc in markets as it fueled further debt and inflation concerns. Dollar dominance continued with sterling pressured despite higher UK yields, and risk off tone is likely to continue as Russia-Ukraine tensions in focus. The yen’s intervention risks also on watch as Japan returns from holiday today. Oil prices slid to multi-month lows amid a stronger dollar and demand concerns, with supply factors turning supportive for now, weighing on energy stocks.
The selloff last Friday continued its long stretch of turbulence, which first kicked off following Powell’s hawkish Jackson Hole speech on August 26, then was exacerbated by a much-stronger-than expected CPI on September 13. And the selloff has most recently been bolstered by the hawkish rate and economic projections released after the FOMC meeting last Wednesday. Adding to the woes, earnings warnings from heavy-weight industrial and transportation companies have warned of weaker demand and an opaque outlook. The S&P 500 lost 12% and Nasdaq 100 dropped 13.9% over the period. Of note, last Friday, financial conditions tightened further, with US 2-year yields soaring to 4.2%, the highest since 2007, while the dollar soared to a new high and dragged down stocks, with both the S&P 500 and Nasdaq ending Friday down 1.7% lower.
All 11 sectors in the S&P500 closed lower on Friday, with Energy falling the most, 6.8%, after WTI crude declined by about 5% to an eight-month low after the US dollar hit its highest level in two decades on fears rising interest rates will tip major economies into a recession. APA Corp (APA:xnas) and Marathon Oil (MRO:xnys) fell about 11%. FedEx (FDX:xnys) fell 3.4% with its US$2.7 billion cost-saving by cutting flights, deferring projects, and closing offices facing skepticism. Ford (F:xnys) fell 3.6%, following a WSJ report that Ford delayed vehicle deliveries due to supply chain issues in getting Ford logo badges to put on its vehicles. On the upside, Generac Holdings (GRNC:xyns), Domino’s Pizza (DPZ:xyns) shares rose the most in the S&P 500 on Friday, gaining 3.2% and 3.1% respectively, perhaps with traders closing shorts as their stocks are continuing to hit new lows on a yearly basis.
In London trading hours before New York came in, U.S. treasuries were rattled by the jaw-dropping, emerging market style meltdown in U.K. Gilts, as 5-year UK Gilts soared 50bps and 10-year Gilts jumped 33bps in yields in an hour, following the announcement of a massive loosening of fiscal policy of nearly 2% of GDP by the new U.K. government. Investors are worried as when the U.K. acted similarly last time in 1972, inflation soared and the U.K. had to go to the IMF for a loan in 1976. When New York came in, bids emerged for U.S. treasuries, in particular, for the long end of the curve. 10-year and 30-year yields fell 3bps to 3.68% and 3.61% respectively while 2-year yields finished the session 8bps higher at 4.20%, the highest level since 2007.
Hang Seng Index continued its losing streak and tumbled 1.2% to its lowest level last seen in 2011. Materials, healthcare, China Internet, EV, shipping, and consumer stocks led the market lower. In the materials sector, Ganfeng Lithium (01772:xhkg) plunged 5%, followed by MMG (01208:xhkg) down 3.6%, and China Shenhua (01088:xhkg) off 3.4%. Despite the weakness in international crude oil prices, PetroChina (00857:xhkg) and Sinopec (00386:xhkg) managed to bounce by around 1.5%. Alibaba (09988:xhkg), Tencent (00700), and Meituan (03690:xhkg) declined by nearly 3%. Hong Kong’s end of hotel quarantine requirement lifted the share price Cathay Pacific (00293:hk) by 1% while Chinese airlines declined moderately. Hong Kong luxury retailers gained, with Oriental Watch (00398:xhkg), Luk Fook and Chow Sang Sang rising from 0.5% to 2.2%. Banks in Hong Kong gained in anticipation of improvement in net interest margins following the lenders increased their prime rates, BOC Hong Kong (02388:xhkg) rising 3.8%, Hang Seng Bank (00011:xhkg) up by 2.5%. In mainland A shares, CSI300 swung between modest gains and losses and finished the day down by 0.3% and declining to within 3% from its April low. In terms of sectors, electronics, semiconductors, autos, coal, and solar power were among the worst laggards, while banks and appliances outperformed.
This week Australia’s share market will likely take its lead from commodity prices pulling back, with oil stocks like Woodside (WDS:xasx), Santos (STO:xasx) and Worley (WOR:xasx) to take a hair cut. Inversely, the coal price has continued to move higher, along with coal futures, so there is likely to be further upsdise in coal stocks including; New Hope, Whitehaven (WHC:xasx) and Coronado (CRN:Xasx) Washington Soul Patts (SOL:xasx).
The dollar rallied broadly, hitting a new all-time high against a currency basket and pushing the euro to a 20-year low while the pound plunged to a fresh 37-year low below 1.10 after the new UK government unveiled a massive fiscal stimulus plan to boost economic growth, which is sure to send inflation soaring even higher and force the BOE to do even more QT. Safe-haven demand also boosted the greenback amid risks from the escalation of Russia tensions and more signs of a slowing Chinese economy, which raised concerns about the outlook for global economic growth.
Crude oil prices fell sharply last week with the focus fixed on demand concerns while supply issues turned supportive. The continued surge higher in dollar and yields, aided by not just the FOMC but also the UK fiscal expansion measures into the end of the week, drove a slump in risk appetite. Brent crude fell to a nine-month low of $86.15/bbl, and this may warrant an OPEC action to support prices. Russia also warned it will not supply commodities to nations that join any agreement to cap prices for its crude. WTI crude traded below $80/bbl in early Asian trading hours as the new week kicked off.
US flash PMIs for September surpassed expectations across the board, as manufacturing rose to 51.8 (prev. 51.5, exp. 51.1) and services, despite remaining in contractionary territory, printed 49.2 (prev. 43.7, exp. 45.0). Composite lifted to 49.3 from 44.6. At the same time, the inflation components of the PMIs continue to show some relief, with the report showing that supplier shortages eased and both cost and selling prices for both goods and services were at fresh lows, while still-high compared to the usual levels.
Both manufacturing and services PMIs for the Eurozone came in weaker-than-expected in a flash reading for September, with rising energy costs and decline in purchasing power weighing on manufacturing activity as well as the services sector. The headline reading fell to 48.2 in September from 48.9 in August. New orders disappointed, and the outlook was bleak as well. Manufacturing continues to be hit harder by elevated commodity prices. The reading slipped to 48.5 from 49.6. The services figure came in a bit higher at 48.9, but still fell from 49.8 in the previous reporting period. While supply bottlenecks eased, surging energy prices suggest these could reverse again.
New UK Chancellor Kwasi Kwarteng announced a mini-budget on Friday, which included wide-ranging tax cuts of the order of GBP 45bn, adding to an estimated cost of GBP 60bn for the energy plan. Instead of stabilizing markets, the announcement sparked mayhem as it promised even more inflation at a time when the UK is set to slide into a crippling stagflationary recession as prices soar. Bank of England last week stuck with a 50bps rate hike as recession is likely on the cards. Bonds were sold off and the sterling dipped to 37-year lows, suggesting UK’s inflation-fighting credibility at stake and demands risk premia.
Over the last four weeks money managers have spent US$34 billion purchasing put options, which provides protection against a further fall in stock markets (according to the Financial Times). According to the article, ‘Investors pile into insurance against further market sell-offs', $9.6 billion was spent in the last weeks alone on options protecting against downside risks.
The Japanese authorities intervened in the currency markets for the first time in two decades last Thursday. USDJPY’s move above 145 following a hawkish FOMC and a still-accommodative Bank of Japan prompted the intervention, and dragged the pair to sub-141 levels before some of the move was retraced. However, Japan was closed on Friday for a holiday, and returns to trading today. Moreover, Governor Kuroda will make a speech and talk to reporters today. We believe the yen could weaken further given the pressure from yield differentials between the US, which continues to rise to fresh highs, vs. the yields in Japan which continue to remain capped. Meanwhile, the intervention last week has been possibly unilateral, suggesting it may not be long-lasting. This continues to raise the possibility of further intervention from the Japanese authorities, especially if USDJPY rises back above 145.
The four Moscow-held regions of Ukraine – Donetsk, Luhansk, Kherson and Zaporizhzhia – began voting on Friday on whether to become part of Russia, and results may be expected this week. The referendums are reminiscent of one in 2014 that saw Ukraine’s Crimea annexed by Russia. The four regions’ integration into Russia – which for most observers is already a foregone conclusion – would represent a major new escalation of the conflict. The threat of nuclear weapons will also keep risk off on the table, with Putin threatening to use “all means” to protect the annexed Russian territory.
Effective from today, Hong Kong ended its requirements for people arriving Hong Kong to be under hotel quarantine. Under the new arrangement, people arrive to Hong Kong from overseas and Taiwan are still required to undergo three days of medical surveillance at home or hotels. They can go out, including taking public transportation and going to work but are still denied access to some public venues such as restaurants during the medical surveillance as well as required to take RAT daily for seven days plus three PCR tests on day 2, 4 and 6 each.
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