Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: U.S. equities and bonds rallied on the November FOMC minutes which has a dovish cast stating “a substantial majority of participants judged that a slowing in the pace of increase would soon be appropriate”. The 10-year treasury yield fell to 3.69%. Oil prices slid sharply on Wednesday with WTI futures dipping to sub-$77 lows as the EU proposed a higher-than-expected price cap on Russian crude - between $65-70/barrel. EURUSD rallied above 1.04 and USDJPY fell below 140 amid broad-based dollar weakness.
U.S. equities found support and bounced after the release of the Nov 1-2 FOMC minutes in an otherwise thin trading session ahead of the Thanksgiving holiday. As bond yields fell, Nasdaq 100 rallied 1%, and the S&P 500 gained 0.6%. All sectors in the S&P 500 advanced except energy, which was dragged by a 4.3% decline in the price of the WTI crude. Consumer discretionary was the top gaining sector, led by Tesla (TSLA:xnas) that surged 7.8% after a leading US investment bank called the shares of Tesla “a bargain”. Deere (DE:xnys), the largest supplier of farm tractors and crop harvesters in the world, gained 5.1% after reporting an earnings beat and upbeat guidance citing strong demand. Manchester United (MANU:xnys) surged 26.1% after the club’s owner announced that they were exploring a sale. Coupa Software (COUP:xnas) jumped nearly 29% on a report that Vista Equity Partners is exploring an acquisition. Nordstrom (JWN:xnys) dropped by 4.2% after reporting a decline in sales and excessive inventory.
The minutes for the Nov 1-2 FOMC meeting have a dovish cast, saying “a substantial majority of participants judged that a slowing in the pace of increase would soon be appropriate” and some FOMC members had a concern about rate hikes might ultimately “exceed what was required to bring inflation back”. Yields declined across the curve with buying particularly strong on the long end. The 2-year yield dropped by 4bps to 4.48% and the 10-year yield finished the session 6bps richer at 3.69%. The 2-10-year part of the curve became yet more inverted at minus 79.
China internet stocks gained, led by Kuaishou Technology (01024:xhkg) up 5.7%, Baidu (09888:xhkg) up 3.4%, JD.COM (09618:xhkg) up 3.3%, and Alibaba (09988:xhkg). Kuaishou and Baidu reported better-than-expected Q3 results. Alibaba shares were boosted by the prospect of coming out of the 2-year-long regulatory overhaul with a fine of over USD 1 billion. Meituan (03690:xhgx) underperformed with a loss of 1.1% following a statement from Prosus, shareholder of Tencent, saying that the Company was planning to unload the Meituan’s shares it received from Tencent. China Aluminum (02068:xhkg) continued its advance, rising 25.3% on Wednesday. Hang Seng Index gained 0.6% and CSI 300 climbed 0.1%. In mainland A shares, infrastructure names surged while pharmaceutical and biotech stocks retreated. Overall market sentiment remains cautious as the number of new cases reached 28,883 on Tuesday, just a touch below the April high of 29,317 cases. Large cities, including Beijing, Chongqing, Chengdu, Guangzhou, Zhengzhou, as well as Shanghai have further tightened pandemic control measures.
The dovish read of the FOMC minutes from the November 2 meeting is hardly a surprise, given the key message has been around a downshift in the pace of rate hikes as expected. But together with weaker than expected flash PMIs for November (read below) suggesting demand slowdown concerns are starting to pick up pace, and a higher-than-expected jobless claims prints sending some early warning signals on the labor market, the focus has completely shifted away from inflation concerns. Market pricing of the Fed December meeting tilted further towards 50bps, and that resulted in a broad-based dollar sell-off. EURUSD surged above 1.04 while USDJPY slid below 139.50.
Oil prices slid sharply on Wednesday with WTI futures dipping to sub-$77 lows and Brent futures touching $84/barrel as the EU proposed a higher-than-expected price cap on Russian crude - between $65-70/barrel after a $60 level was touted yesterday. This higher price cap means that Russian oil can continue to flow into the international markets as it is above Russia’s production costs. Meanwhile, EIA data showed US crude inventories fell a more-than-expected 3.69 million barrels last week, but US gasoline stockpiles rose by 3 million barrels, the largest buildup since July, suggesting a weaker demand heading into Thanksgiving.
The FOMC minutes from the November 2 meeting were released on Wednesday, and the general tone of the members confirmed that the committee was leaning towards moving away from jumbo (75bps) rate hikes to a smaller pace. At the same time, "various" officials noted that the peak rate will be "somewhat higher" than previously expected. The minutes saw participants agree there were very few signs of inflation pressures abating (minutes were pre-October CPI) and they generally noted inflation outlook risks remain tilted to the upside. There were also some concerns about the strength of the labour market, where a few participants said ongoing tightness in the labour market could lead to an emergence of a wage-price spiral, even though one had not yet developed. The message remained less hawkish than what the Fed potentially needs to deliver at this point given the considerable easing in financial conditions.
US S&P flash PMIs for November disappointed, as manufacturing printed 47.6 (exp. 50.0, prev. 50.4) and services fell to 46.1 (exp. 47.9, exp. 47.8), while the composite dropped to 46.3 (prev. 48.2). New orders fell to 46.4, the lowest since May 2020, while employment saw a slight uptick to 50.8 from 50.4. The only good news is that both input and output prices dipped further, offering further positive signals on inflation. The PMIs indicated how concerns are shifting from the supply side to the demand side, with better news on supply chains but demand concerns from weakening new orders. Initial Jobless claims rose more than expected to 240k from 223k and above expectations of 225k, the highest print since August, suggesting that we continue to watch for further signals on whether the tight labor market may be starting to weaken.
This was unexpected. The consensus forecasted that the EZ flash Composite PMI would fall to 47.0 in November from 47.3 in October. It actually improved a bit at 47.8. The increase mostly results from a better-than-expected Manufacturing PMI (out at 47.3 versus prior 46.4 and forecast at 46.0) while the services sector remains stable. There is another positive news. Price pressures are easing quite fast. The PMI price gauge fell to its lowest levels in two years due to a collapse in input prices. On a flip note, the flash Composite PMI Output Index for the United Kingdom (UK) ticked up to 48.3 in November. Surprisingly, the UK seems to hold up better than the eurozone and especially Germany. The jump in the PMI is still consistent with a recession in the eurozone and in the UK but it may be shallow and its steepness will mostly depend from country to country on the impact of the energy shock and fiscal measures taken to mitigate it.
After a meeting on Wednesday, China’s State Council issued a memo calling on the People’s Bank of China (PBOC) to use monetary tools including a cut in the reserve requirement ratio (RRR) at an appropriate time to support the real economy. According to historical observations, the PBOC will do what the State Council says and cut the RRR in the coming days or weeks.
Video clips showed violent protests broke out at Foxconn’s iPhone production plant in Zhengzhou. What exactly caused the protests were unclear but speculation was about retention allowance to workers who are willing to stay at the factory until February 15, 2023, and work conditions.
The market was divided on whether the bank would go with the larger rate hike after a string of 50 basis points moves prior to the meeting overnight. NZ two-year yields jumped back toward the cycle highs overnight as the market participants raised the anticipated peak in the policy rate by mid-year next year to almost 5.50%, up about 30 basis points after the decision.
Xiaomi reported Q3 revenue of RMB70.47 billion, shrinking 10% Y/Y and flat Q/Q. Adjusted net profit came in at RMB2.1 billion, 6% above the Bloomberg consensus, and -59% Y/Y and +1% Q/Q. Excluding new initiative investment, core net profit increased 9% Q/Q to RMB2.9 billion. Blended ASP declined 4% Y/Y. Gross margin was 16.6% in Q3, falling from 16.8% in Q2 and 18.3% a year ago. Q3 non-IFRS operating margin was 3.0%, down from Q2’s 3.1% and Q3 last year’s 6.7%.
The Swiss bank is stating in a press release this morning that it could lose $1.6bn in Q4 driven by losses in its investment banks. In addition, the bank says that it has seen net outflows of 6% relative to AUM in Q3. To improve profitability the bank is one-third of all investment banking employees in its Chinese subsidiary following a recent staff expansion in the country.
The technology company reported Q4 results yesterday in line with estimates but its FY2023 (ending 31 October 2023) outlook was below estimates with adj. EPS guidance of $3.20-3.60 vs est. $3.61. Over the next two years the company expects to reduce staff level by 6,000 to improve profitability.
The owner of Manchester United said that they are exploring the sale of the English Premier League football club and will consider “all strategic alternatives”. In May this year, Chelsea, another English Premier League club, was sold for around USD5.3 billion.
Deere said they are expecting high demand for equipment from farmers on elevated prices for agricultural commodities. In addition, the company expects increases in demand for its construction machinery from the oil and gas industry and construction equipment rental businesses. Strong progress in precision agriculture adoption is expected to help boost margins and aftermarket technology product sales.
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