Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: U.S. equities gained and Treasuries sold off on stronger-than-expected U.S. data headlines, including a 2.9% growth in Q4 GDP, a decline in the initial claims to 186K, a 5.6% increase in durable goods orders, and a rise in new home sales. The Nasdaq 100 closed above its 200-day moving average for the first time since March last year. Hong Kong came back from the Lunar New Year holiday rising 2.4% on high-frequency data that pointed to a strong recovery in traffic and consumption during the Lunar New Year holiday in mainland China. Today all eyes are on the PCE data as it may set the direction of the next move of equities and bonds.
The major US indices had a choppy day of trade, with the S&P 500 rebounding and ending up 1.1%, and the Nasdaq 100 finishing the session 2% higher. Investors digested slower US economic GDP growth data but better-than-expected from the fourth quarter, as it tends to suggest that the US economy could make a soft landing. Nasdaq 100 closed above its 200-day moving average for the first time since March last year. 10 of the 11 S&P 500 sectors gained with energy, up 3.3%, and consumer discretionary, up 2%, leading the charge higher.
Tesla’s shares jumped 11% on Thursday, extending its rally from its January 6 intra-day low to over 57%, with earnings and revenue beat expectations, while investors looked past automotive gross margins grinding to its lowest figure in five quarters, 25.1%. Also, despite a streak of quarterly sales (deliveries) coming up short of expectations, Musk teased the potential to produce 2 million vehicles this year, and minimise the effects of drastic price cuts to its EVs.
American Airlines Group expects profit this year to exceed estimates following a slow start, as steady demand for air travel keeps an industry recovery going into 2023. Mastercard warned revenue growth would slow even faster than expected this quarter, stoking fears that inflation has put a damper on consumer spending.
U.S. Treasures sold off after the stronger-than-expected economic headlines. Real GDP grew at 2.9% annualized in Q4, faster than the 2.6% median forecast, though more than half of the increase came from a rise in inventories. Initial jobless claims fell to 186K instead of rising as in the consensus forecasts. New home sales rose 2.3% sequentially against expectations for a decline. Durable goods orders grew 5.6% M/M while the median forecast expecting for a decline. The 7-year auction had strong demand with a strong bid-to-cover ratio of 2.69 times and was awarded 2bps richer than the market level at the time of the auction. Yields on the 2-year notes settled 6bps higher at 4.18% and the 10-year finished the session cheaper at 3.49%.
On the first trading day of returning from the Lunar New Year holiday while the mainland bourses remain closed, Hang Seng Index surged 2.4% and Hang Seng TECH Index jumped 4.3%. According to Xinhua News, the State Council estimates that passenger trips over the whole Lunar New Year peak transportation period are reaching 2.1 billion, almost doubled the number from last year. Separately, data from the Ministry of Transport showed that daily passenger trips between 7 and 25 January averaged nearly 37 million, a 50.8% growth from last year. Tourism consumption data from Ctrip and cinema box offices have also been encouraging. It added to the optimism that the initial Covid outbreak when pandemic containment measures were lifted has not stalled the rebound in mobility and economic activities. Xiaomi (01810:xhkg), surging 12.5%, was the best performer within the benchmark Hang Seng Index, following the leak of an EV blueprint design being considered as an indication of the mobile phone and electronic device maker is on track to launch its first EV in 2024.
FX: CAD boosted by higher oil prices; JPY stronger on Tokyo CPIThe US dollar was modestly higher on Thursday with upbeat US GDP and claims data supporting the case for a soft landing. Focus now turns to PCE and the earnings season ahead of the Fed meeting next week where the broad consensus is still for a step down to a 25bps rate hike. CAD was the clear outperformer across the G10 board, despite Bank of Canada’s dovish tilt this week as higher oil prices supported. USDCAD now testing a break below 1.33. EURUSD still getting rejected close to YTD highs of 1.0930, but JPY was one of the underperformers as USDJPY traded back above 130 amid somewhat higher US yields but a dip back below 129.70 was seen in early Asia as Tokyo CPI for January came in above expectations.
Australian producer inflation (as measured by the Producer Price Index), has been trending higher, however today’s data from Q4 suggests producer prices are easing. However we believe that this is not an accurate reflection of reality. Not only is the data quarterly, but raw material prices (oil, electricity, fuel, copper, rent) are trending higher. As such the Australian dollar holds at 0.7127, after rising up 0.2%. The next test for the Aussie dollar will be Friday’s PCE data from the US and Tuesday’s RBA commentary with an expected 0.25% (25bps) hike on the cards. All in all, we believe the AUD is supported higher over the medium term, following a series of hotter than expected CPI prints, while China’s reopening is supporting the AUD with commodity demand rising. Still we continue to watch if the 50 day simple moving average crosses above the 200 day, marking a ‘golden cross’, which could lead to another quick run up.
The demand outlook for commodities got another boost on Thursday with upbeat US GDP report for Q4 and a still-low initial claims weekly print highlighting the tight jobs market. Th30e recovering demand outlook in the short run also saw Brent structure flipping to backwardation from contango. Brent futures were up 1.7% to $87.50 but our Head of Commodity Strategy, Ole Hansen, writes that Brent is likely to find resistance at $100 in the short-term, with recession risks offsetting an expected rebound in Chinese demand and supply concerns related to the February 5 introduction of an EU embargo on Russian seaborne sales of fuel products. WTI futures inched back above $81/barrel.
With the upbeat US economic data releases on Thursday, there was increasing conviction that the Fed could still deliver a soft landing vs. a deep recession that some had started to forecast at the end of 2022. This prompted some profit-taking in Gold which closed at a nine-month high and very close to the key resistance of $1950 a day before. Spot prices slumped close to 0.9% to close near $1930, with support seen at $1900 with resistance at $1963, a Fibonacci level.
Copper prices lift 0.5% to $4.27, and are now up 32% from their lows. The wiring and industry metal outlook remains bright amid the clean energy transition, while mines will need to produce more than needed over the next two years to meet demand. However there is a risk Latin America will ramp up output, which could see prices correct.
The advance print of US GDP came in at a stronger-than-expected +2.9% YoY (vs. 2.6% YoY exp) for the fourth quarter from 3.2% YoY in Q3. While the strong headline, together with another sub-200k print for the weekly jobless claims, coming in at 186k vs. 205k expected, suggested that the US economy was holding up strongly in the wake of rapid Fed tightening, the details were still patchy. Importantly, personal consumption, key to gauge how the consumers are holding up, climbed at a weaker-than-expected pace of 2.1% YoY. Focus now turns to Fed’s preferred inflation gauge, the PCE data, due to be released today. The disinflation impulse is likely to stretch further, as has been evident from CPI releases lately, likely continuing to build a case for a 25bps rate hike by the Fed next week.
The BOJ should consider increasing flexibility in long-term yields, the IMF said, highlighting that the risks to inflation are tilted to the upside with exceptionally high uncertainty. Options include raising its 10-year yield target, widening the trading band, switching back to a quantity goal for bond buying and aiming at a shorter-maturity yield. Japan needs to see a 3% across-the-board rise in nominal wages to anchor CPI above the BOJ's 2% target, fund Deputy MD Gita Gopinath said.
The European Union is floating a plan to cap the price of Russian diesel at $100 a barrel from February 5 (the same date as the EU will ban almost all imports of refined Russian products). For reference, diesel futures are currently trading at $130/barrel, as they usually trade at a premium to crude. A lower $45 threshold would be set for discounted fuels like fuel oil, but member states will need to unanimously agree to the final figures. The objective remains to keep the Russian flows coming but cut Moscow’s revenues.
Tokyo CPI for January came in above expectations, with the headline rising to 4.4% YoY from a revised 3.9% YoY previously and estimate of 4.0% YoY. The core measure rose to 4.3% YoY from 3.9% YoY while the core-core measure was also higher at 3.0% YoY from 2.7% YoY in December. This makes way from another beat in the overall CPI for January as well, and saw USDJPY down by about 50pips in response to 129.70 after a modest rise in the US session as US yields rose. Asia’s inflation surge from Australia to New Zealand to Japan is raising concerns on how China’s reopening could potentially fuel another leg of price pressures globally as commodity prices surge.
Consider Australia is often considered an investment proxy for China and Aussie exchange-traded funds (ETFs) could draw flows as China's economy reopens from Covid. The Australian equity market is frequently a dividend and commodity play, tilting heavily to financial and materials sectors. Mining company BHP Group expects dividend growth of 17% while the top iron ore miners are expected to ramp up shipments, underpinning higher earnings. Insurers, banks and financials could benefit most from RBA rate hikes with QBE and Westpac most sensitive to rising interest rates, with 60% and 40% profit boosts expected for them this year amid higher earnings on assets. The ASX200 is up 16% from its low and total aggregate earnings growth of over 30% is likely to unpin further growth for the market.
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