Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equities are a mixed bag globally after the strong session yesterday in Europe was followed by a choppy session in the US, which was boosted late by strong Tesla results reported after hours. Chinese equities continue to head south in a hurry, while Japan enjoyed a strong session as the JPY remains weak. Elsewhere, the euro is steady after the debate between the two contenders in the French presidential election run-off ahead of the Sunday vote.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equities were undecided yesterday but is pushing higher in early European trading hours with the S&P 500 futures trading around the 4,475 level; watch the 200-day moving average at 4,490 on the upside if momentum continues. Better than expected earnings from Tesla have lifted sentiment and today’s initial jobless claims and Philadelphia Fed Business Outlook for April will likely show that the US economy continues at a pace significantly above trend growth.
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I) - fell 1.5% and 1% respectively on rising concerns about sharp deceleration in growth in China. Hang Seng TECH Index (HSTECH.I) fell more than 3%, with Meituan and JD.COM down 6% and 5% respectively. Mineral producers, Ganfeng Lithium and MMG fell 7% and 5% respectively. Auto names fell over 5% across the board.
Stoxx 50 (EU50.I) – sentiment on Stoxx 50 futures has improved lately despite the war in Ukraine is intensifying and Russia making more threats against the EU and NATO. Stoxx 50 futures are trading around the 3,833 level in early trading with the 50-day moving average around the 3,846 level being the key level to watch today on the upside as the index futures have not been above this moving average since 10 February.
USDCNH – the CNH weakness extended above 6.45 in USDCNH, with this week’s rally of well over 1% representing the largest weakening move in the CNH versus the US dollar since early 2020 if even current levels hold through the Friday close. The next major chart level is an early pivot high from 2021 near 6.58. The yield advantage China enjoyed over the US no longer exists, recent data show that foreigners are pulling their bond investments in China at a record clip, and growth concerns are weighing on Chinese assets as the country continues to pursue severe Covid lockdown policies.
EURUSD, EURCHF and other EUR pairs – the euro staged a modest rally against the US dollar yesterday, mostly significant only in that it came just after the pair posted a new cycle low below 1.0800 before doing so. Short-term implied volatilities for options are elevated ahead of this Sunday’s run-off vote in the French Presidential election between right populist Marine Le Pen and incumbent Emmanuel Macron, as a Le Pen victory would be a game changer for the EU, particularly for the narrative of more solidarity that has developed in the wake of the Russian invasion of Ukraine. EURCHF has rallied sharply this week, perhaps as traders position for a Macron victory and as CHF is feeling some pressure from the sharp rise in global bond yields. Early next week will tell us how much this French political situation has held back the euro, with many traders possibly looking back at the last race in 2017, when the euro rallied hard from low levels in the wake of the French election between the same two candidates that saw Macron handed an overwhelming win.
Gold (XAUUSD) continues to consolidate following its failed attempt to reach and breach the important $2k level on Monday. While US real yields briefly turning positive attracted some negative price attention gold traders and algo’s have increasingly been finding directional input from crude oil, a development that given the current situation makes sense. The ebb and flow of the oil price impacts inflation through the cost of refined products while its strength or weakness also tell us something about the level of geopolitical risks in the system. While higher interest rates may weigh, worries about inflation, growth, and increased market volatility together with the war in Ukraine remain the key reasons why asset managers continue to accumulate exposure.
Crude oil (OILUKJUN22 & OILUSMAY22) continues to trade within a narrowing range around $107 in Brent and $103 in WTI. Beneath the surface, however, the market is anything but calm with supply disruptions from Libya and Russia currently being offset by lower demand in China where officials are struggling to eradicate a wave of Covid-19 in key cities. In the US last week, strong exports pushed total petroleum exports to a record high and crude stocks down 8 million barrels, despite a 4.7-million-barrel release from Strategic Reserves. Refineries are seeing record margins underscoring the high prices US and other buyers are forced to pay while cutting reliance on Russian oil. European ban on Russian crude oil and fuel imports, remains a major upside risk.
US Treasury yields surged across the curve (IEF, TLT). Short US yields remain near cycle highs after the Fed Beige Book report on the economy suggests a solid pace of expansion and ongoing inflationary risks. The longer end of the US yield curve saw yields reversing sharply from new highs although yields quickly steadied only several basis points below the Tuesday closing level even as a 20-year Treasury auction saw strong demand late yesterday.
What is going on?
Fed Beige book shows “moderate” growth, ongoing inflation risks. The headline looks rather tepid in that the Fed’s beige book report on the economy noted a “moderate” expansion of economic activity, but some details in the report pointed to solid strength, including accelerating consumer spending. The report also pointed to recent worsening in supply chain challenges, strong wage growth, particularly for lower paid positions, and strong inflationary pressures, particularly in rents. In other news, Fed’s Daly indicated the case for a 50 basis point interest rate hike in May is now “complete”. An announcement on the balance sheet could happen next month too.
Tesla shares gain 5% on record profits. The world’s largest pure EV-maker delivered better than expected Q1 results with revenue at $18.8bn vs est. $17.9bn and EPS at $3.22 vs $2.27, but more impressively free cash flow hit $2.2bn vs est. $672mn. The EV-maker expects supply chain issues to remain a key issue for the rest of 2022 and the company also said that profits in the future will be tied to software.
Canada March inflation rises more sharply than expected, with the headline CPI measure in at +1.4% month-on-month versus 0.9% expected, and the year-on-year CPI at +6.7% versus 6.1% expected. The “Core-Trim” year-on-year measure was likewise at a new multi-decade high of +4.7%. The Canadian dollar rose sharply on the data as the market priced in more tightening from the Bank of Canada, which is now priced to hike by 50 basis points at its next three meetings in a row, with the policy rate tightening seen continuing to outpace the Fed. As well, Canadian home prices rose at an 18.4% year-on-year clip in March, matching the fastest pace of house price appreciation for the cycle.
Positive eurozone industrial production in February. It increased by 0.7 %, following a decline in January. But we should not pay too much attention to this number which is likely not very relevant. February is the final month of data that does not incorporate the impact of the war in Ukraine. Expect the outlook to be gloomier in the coming months.
NZ Q1 inflation comes in slightly below expectations although still at the highest in over 30 years, with the year-on-year headline CPI at 6.9% versus 7.1% expected and the quarter-on-quarter rise at +1.8% versus +2.0% expected. The NZD was marginally weaker after spiking lower, with AUDNZD trading just shy of 1.1000 at one point before retreating.
BHP (BHP), Rio (RIO), and Vale (VALE3) the world’s biggest mining companies reported quarterly iron ore shipments fell amid COVID staff shortages and outages, yet BHP maintained its full-year guidance. Rio (RIO) highlighted the current inflation environment was unlike anything the global economy had witnessed in almost half a century. On a like for like basis, Vale’s full year revenue growth is expected to slow, along with its profits, while BHP’s revenue and profit growth is expected to rise in 2022 (64% gross profit growth, 10% revenue growth is expected), while the market thinks Rio’s revenue will slide this year.
What are we watching next?
Geopolitical risk on the rise. Russia said it test fired a new nuclear-capable intercontinental ballistic missile, suggesting that the geopolitical risk is on the rise amid the on-going Ukraine/Russia conflict. Russian forces are now concentrating its efforts to capture eastern Ukraine, while the US & allies are sending more military aid to Ukraine forces.
EV battery shortages are becoming severe. We heard from Rivian’s CEO recently saying that EV-makers will soon experience a dramatic shortage of batteries that could surpass the worst seen in computer chip shortages. Now, Elon Musk has made a public appeal for more investment in lithium mining as well. There is a huge demand-supply gap there and this could mean higher EV prices. A strong consumer, as is evident from the ongoing earnings season, certainly bodes well for higher EV prices in the coming months.
Earnings Watch. Today’s earnings focus is CATL (the world’s largest maker of batteries for EVs), and especially given Tesla’s earnings last night, but otherwise focus is on ABB, Danaher, NextEra Energy, and Snap.
Economic calendar highlights for today (times GMT)
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