Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equity markets steered away from the cycle lows in the US but failed to close yesterday’s session with any conviction. In the UK, the GfK consumer confidence report for May out overnight registered a record low in the almost 50-year history of the survey. Currency markets are on edge as falling safe-haven bond yields could threaten significant Japanese yen volatility, while the USD has been on its back foot as a growing cohort of economic data suggests a slowing economy.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - a choppy US equity session yesterday with a large intraday trading range relative to the overall change (close-to-close) for the session. This morning the market is attempting a push higher with Nasdaq 100 futures trading above the 12,000 level which has turned out to be a key pivotal area where buyers are coming in. Economic data yesterday showed renewed weakness in the labour market (initial jobless claims) and the leading indicators, which have now flatlined over the past couple of months and could continue to add to the negative sentiment. The key level to watch on Nasdaq 100 futures is around yesterday’s high at 12,076.
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I) - rallied 2% and 1.8% respectively after Chinese banks cut their 5-year Loan Prime Rate (5yr LPR) by a larger than expected 15bps to 4.45%. 1-year LPR remains unchanged at 3.7%. Coal mining stocks surged 5% to 7% after Premier Li Keqiang vowed to ensure no disruption to electricity supply. Xiaomi (01810) reported revenues in line with market expectations but operating income and EPS disappointed due to higher operating expenses and losses in investments.
Stoxx 50 (EU50.I) - Stoxx 50 futures briefly pushed below the 3,600 level before quickly rebounding to end yesterday’s session above 3,600 and this morning they are rebounding further to around 3,650 finding themselves in no man’s land. The 50-day moving average (currently around 3,726) has been tested four times recently and continues to be an important gauge of strength for European equities.
AUDUSD – the AUDUSD is one of the key USD pairs to watch at the moment as it trades up in a pivotal area above 0.7000 that could suggest a more profound reversal of the late USD bull trend, one that could open up for a move as high as 0.7250 if not yet fully reversing the USD rally (A prominent pivot is at 0.7266 with the 200-day moving average currently near the same level). The Aussie rose above a local high-water mark near 0.7050 late yesterday, but faltered in Asian hours before rising again, perhaps on hopes that Chinese stimulus plans and a record cut in long term loan rates by Chinese banks will buoy the Chinese economy and demand for Australian exports. The Chinese yuan was sharply higher overnight as well.
USDJPY and JPY pairs – the JPY rallied sharply again yesterday as the safe-haven sovereign bonds rallied again – taking USDJPY down through the local pivot low of 127.50, if only briefly, as yields failed to stick lower. As well a sharp intraday crude oil sell-off (nominally JPY supportive due to Japan’s import reliance) reversed sharply. Still, the volatility shows how sensitive JPY pairs are to the combination of risk sentiment and safe-haven yield direction. As well, the speculative positioning in JPY is quite extended, such that any fresh forward concerns on the longer-term economic outlook that takes global bond yields lower could drive significant JPY volatility. After yesterday’s action, we’re watching 127.00 as the next important area in USDJPY, followed by the 125.00 level, which was a significant sticking point on the way up.
Gold (XAUUSD) closed above its 200-day moving average at $1838 yesterday with the next significant hurdle being $1868, the 38.2% retracement of the recent 210-dollar correction. Fragile risk sentiment driven by worries about the outlook for growth and high inflation has given bonds a boost while softening the dollar (see above), both positive drivers for gold. Total holdings in bullion-backed ETFs rose yesterday for only the second time out of the last 19 trading sessions. Silver (XAGUSD) meanwhile has returned to relative safety around $22 after recently hitting a 22-month low at $20.46.
Crude oil (OILUKJUL22 & OILUSJUL22) remains rangebound, caught between focusing on tight monetary policy driving an economic slowdown and a tightening global fuel-product market. A situation that may worsen once China manages to lift lockdowns which has battered its economy while reducing demand for commodities from metals to fuel products. China’s import of cheap Russian crude rose to a three-month high in April as the country sent about 2 million barrels per day of crude oil into storage tanks. The mentioned tightness in global fuel products will underpin fuel prices, already at record levels around the world, ahead of the summer driving seasons. So, despite the prospect for slower global economic growth, the price of crude oil remains supported.
US natural gas (NATGASUSJUN22) trades lower after earlier in the week twice finding resistance around $8.5/therm. The price trades higher by 200% compared with the same time last year with record exports via LNG, flat production growth and a recent heatwave across the southern states increasing demand for cooling. However, the weekly injection of 89 billion cubic feet (bcf) to 1732 bcf was in line with expectations and helped reduce the deficit to the 5-year average to 15.2%. In addition, milder weather ahead and Europe suffering from a temporary bout of LNG indigestion could suggest a period of stable prices, but overall rising global demand and a sharp discount to prices in Europe and Asia is likely to prevent any significant weakness during the coming months.
US Treasuries (TLT, IEF) - US longer yields dipped sharply yesterday to the lowest levels in three weeks on weak US economic data (more below), but the move faded a couple of basis points above 2.75%, with new selling coming in and driving the yield back toward 2.85% later in the day. An auction of 10-year inflation-protected treasuries saw the weakest demand since a late 2020 auction fo the same securities.
What is going on
Comeback week for industrial metals, up close to 5% and its first weekly gain in eight led by zinc and aluminum. Supported by a weaker dollar and focus on China lockdowns easing and after Chinese banks cut a key interest for long-term loans (see above) to boost loan demand, as consumer and business confidence has been battered by Covid lockdowns. cut in borrowing rates. HG copper (COPPERUSJUL22) trades above its 21-day moving average for the first time in a month.
Weak US data but Fed speakers remain hawkish. Existing home sales in April fell to 5.61m annualised (est. 5.65m, prior 5.75m), the lowest reading since June 2020 but still above pre-pandemic levels. The Leading Index for April fell 0.3% m/m (est. flat, prior revised lower to +0.1% m/m) amid weak consumer expectations. Weekly initial jobless claims were 218k (est. 200k, prior revised from 203k to 197k). The Philadelphia Fed business survey for May disappointed as well at 2.6 (est. 15.0, prior 17.6). FOMC member George reiterated what Powell said about raising rates till inflation backs down even if that means soft landing, and that they won’t back off due to the slide in equities.
Bipartisan group of US Senators introduce legislation aimed at breaking up Google’s ad business. The proposed Competition and Transparency in Digital Advertising Act would prohibit companies with more than $20 billion in annual ad business from participating in more than any single link in the advertising business. Currently, Google, a unit of Alphabet Inc. (GOOGL:xnas) operates both an exchange for ads and tools that companies can use for buying and selling ads on the exchange.
Japan’s headline inflation at 7-year highs. Japan April CPI accelerated at the steepest rate since October 2014, up 2.5% y/y from 1.2% y/y in March. Core inflation (ex food) increased to 2.1% y/y, the highest since March 2015, from 0.8% y/y last month. This was above the BOJ target of 2% for the first time since 2015 and reflected gains in energy prices especially as cheaper phone fees faded away. Pent-up demand may shield the economy from the impact of rising prices for now and provide room for the BOJ to stay accommodative especially as trade data and private investment hint at a slow Q2 GDP growth as well.
Palo Alto earnings reaffirm our cybersecurity theme. PAW Q3 FY2022 earnings delivered a beat with EPS $1.79 vs. $1.68 expected on a revenue of $1.39 billion vs. $1.36 billion expected. Outlook was upbeat as well, and the stock jumped higher by 11% in after-hours trading to 484.50. Other cybersecurity firms like Crowdstrike (CRWD) and Zscaler (ZS) got a lift as well in the post market session and reports earnings next week. The evolution in global digitalisation demands an equivalent increase in cyber protection, and with the growing volume and complexity of cyberattacks, we expect the cybersecurity industry to continue to show high growth numbers relative to the general equity market.
What are we watching next?
The number of M&A operations in Euronext Paris is increasing fast. Several operations have been announced over the past few days in various sectors: logistics (Air France-KLM and the French shipping firm CMA CGM), green transition (Albioma and the U.S. investment fund KKR), collaborative supply chain (Generix Group), and software intelligence (Cast and Bridge Point), for instance. There are also takeover rumors for the French video game company Ubisoft and Olgroup Multimedia. Ubisoft’s takeover is unlikely to be successful, however. The founding Guillemot family is reportedly looking to buy out all company shares and take the company private to prevent the operation. The share is up 36 % month-over-month. In some cases, the increase in M&A operations is partially explained by lower valuations due to the ongoing market turmoil.
US economic data. The past week we have had another weak surprise in initial jobless claims, and two weaker than estimated regional manufacturing surveys (Empire and Philly Fed), and yesterday’s leading indicators index showed that the US economy is losing momentum.
Earnings Watch. There are no material earnings releases today and in general the Q1 earnings season is now ebbing out with minor relevance to the equity market. The list below shows next week’s earnings releases:
Economic calendar highlights for today (times GMT)
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