Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Bond yields surged and the US dollar picked up strength once more, pressuring US equities for the fifth day. The S&P 500 finished Monday at its lowest closing level in 2022. Investors continued to dump the U.K. Gilts and the Pound Sterling. Australia’s ASX200 could be boosted by M&A and earnings, but pressure remains. China’s central bank raised its risk reserve requirement on banks’ forward FX sales. Australia’s Federal government considers new coal mines, we cover what you need to know. For the latest in markets, with trading and investing ideas, read today's market insights.
The sell-off in equities continued as bond yields continued to surge, and the US dollar picked up strength, which pressed the S&P500 lower for the 5th straight day, seeing the index for the biggest 500 stocks fall 1%, while the Nasdaq 100 gave up 0.5%. The S&P500 not only took out June’s low but closed at its lowest level in 2022. VIX jumped to 32.3. And we think the market is now trading at a level that could perhaps see a very short-term relief technical rally, with the market in oversold territory and the S&P500 trading 9% under its 50-day moving average. Although we could see quant traders likely to swoop and trigger a rally, we emphasize that headwinds still remain in place; as bond yields and the USD are still charging, financial conditions and valuation remain pressured by the Fed’s pledge to tighten liquidity, and we are still likely to see more earnings downgrade. So the overarching pressure on equities remains, which is why we think a potential rally will likely be very short-lived.
After falling 1.6% on Monday to 6,469, the Australian share market opened 0.4% higher on Tuesday boosted by earnings results and M&A talk. A company to watch might be Santos, after selling down its PNG LNG in a $1.1 billion deal. Another company to watch is Synlait Milk as it tripled its financial 2022 net profit after tax to NZ$38.5 million, after sales rose 21% to $NZ1.66 billion. Over 2021/2022 the average milk price was NZ$9.30 per kilo of milk solid, and it forecasts for that to rise to an average of NZ$9.50 in 2022/2023. The milk company gave few clues about profits ahead with no financial guidance, but it expects a similar level of profitability in financial 2023 as in financial 2021.
Continuous melt-down in U.K. government bonds (10-year Gilt yields jumped 42bps to 4.24%) across the pond and a poor 2-year U.S. treasury note auction pushed treasury yields to a new high, with the 10-year note yielding soaring 24bps to finish the day at 3.92%, putting the psychologically important 4% handle within reach. The 2-year yield rose 14bps to 4.34%. The 10-year real rate, represented by the 10-year Treasury Inflation-Protected Securities (TIPS) jumped to as high as 1.62% before settling at 1.59%, a new high since 2010.
Hang Seng Index fluctuated between modest gains and losses and finished the session 0.4% lower. HSBC (00005:xhkg) and Standard Charted (02888:xhkg) tumbled more than 7% as the Pound Sterling was in turmoil. The market however was supported by rallies in China internet stocks, with Meituan (03690:xhkg) up by 4.5%, and Tencent (00700:xhkg) rising nearing 3%. Macao said that it will resume receiving tour groups from mainland China in November. The news boosted Macao casino stocks, Sands China (01928:xhkg) soared 15.7%, followed by SJM (00880:xhkg) and Wynn Macau (01128:xhkg) each rising more than 11%. XPeng (09868:xhkg) jumped 8.7% after the EV maker’s founder bought USD30 million worth of shares in the company. Ahead of the National Day golden week holiday, China catering stocks surged, led by Xiabuxiabu’s 14.4% surge and followed by Haidilao (06862:xhkg) and Jiumaojiu (09922:xhkg) rising more than 6%. Following the plunge in gold prices, share prices of gold mining companies dropped sharply, led by Zijin Mining (02899:xhkg) falling nearly 9%, Zhaojin Mining declining more than 5%. In mainland bourses, tourism, catering, semiconductors, solar power, and EV stocks rebounded. CSI300 Index fell 0.5%.
Sterling reversed from the flash crash seen in the Asian session on Monday, and thin liquidity conditions may be a reason for the sharp drop. The new all-time lows were set at 1.0350 but GBPUSD recovered later to trade closer to 1.0800-levels even as BOE’s lack of action (read below) continued to weigh on sterling. BOE’s Chief Economist Pill is scheduled to make a statement on Tuesday, and lack of real action may mean further downside in sterling. EURGBP below 0.90 may mean room for further spikes as the UK inflation picture deteriorates significantly.
The 10-year Japanese government bond futures tested the Bank of Japan’s yield cap of 0.25% this morning as global bonds continued to be sold off following the hawkish Fed last week doubled up by the UK fiscal plan. Japan’s 2-year yield also rose above 1% for the first time since 2015, but these are outside the scope of BOJ’s yield curve control policy. This suggests the central bank may need to increase the pace of its bond buying for longer maturities, as it did in June. USDJPY is also back in close sight of 145, the level above which we saw the direct intervention by the Japanese authorities last week. Still, the scope for intervention may be lower this time as the yen has strengthened against most other currencies other than the USD. EURJPY is still below 140 from 143+ levels at the time of intervention, while GBPJPY is down from 164 to ~154.
Crude oil prices stabilized in the Asian morning after dipping to the lowest levels since January as tighter global monetary policy continues to underpin recession concerns. Meanwhile the rally in the US dollar continues to stretch further, as we had expected, weighing on the overall commodities sector. WTI futures drifted closer to $77/barrel while Brent futures stayed below $85. Hawkish Fed remarks overnight continue to underpin more USD gains, but the question now is at what levels OPEC will step in to pare supplies and stem the rout.
As a fallout from UK’s fiscal plan, the sterling slid to record lows of 1.0350 on Monday and this prompted calls for an immediate action from the Bank of England to stem the slide in the currency or stabilize inflation expectations. However, all that the BOE did was to try to calm the market nerves with some words rather than action, and delayed any hopes of a rate hike to the next meeting scheduled on November 3. The risk of rate hikes being ineffective to restore sterling credibility may be seen, but BOE’s currency reserves are also rather limited and can only cover about two months of imports. This suggests sterling can remain prone to more wild swings.
Cleveland Fed President Mester was on the wires in the late US hours, reaffirming that further rate hikes will be needed and will need a restrictive stance for some time, while she added it can be better to act more aggressively in an uncertain environment and that pre-emptive action can prevent the worst-case outcome. Collins also spoke about getting inflation under control even if that mean deteriorating labour markets, while Logan (2023 voter) also stressed on the 2% inflation goal. Fed’s 2023 rate cuts bets are easing since the hawkish FOMC last week, More Fed speakers are lined up for Tuesday, including Powell, Bullard, Evans and Kashkari. However, focus may be more on what BOE’s Chief Economist Pill has to say.
Germany’s Ifo business-climate index fell to 84.3 points in September from a revised figure of 88.6 points in August, data from the Ifo Institute showed Monday. This is its lowest value since May 2020 and below expectations of 87.1. The Ifo president said that the German economy is slipping into a recession, as business confidence worsened considerably due to the escalating energy crisis.
The EU countries announced they will delay the introduction of an oil price cap on Russian imports. At least two countries, Cyprus and Hungary (the Hungarian government is one of the most vocal European governments criticizing the sanctions against Russia) have expressed opposition to the oil cap proposal. Expect intense negotiations ahead in order to reach a compromise. For this matter, the EU requires unanimity among member countries. Each country has an effective veto.
The Australian Federal government is considering 29 applications for new expanded coal mines. Coal is already a AUD$63 billion export industry for the nation down under and supported its trade surplus growing to a record. The extra capacity will be able to produce 250 million tones a year. If some or all mines are approved, it will likely cause selling in coal equities in the short term. However, given most of Australia’s coal is exported to India, and green resources will not be able to power Australia’s grid until 2024 (off peak for retail Australians only), the coal price remains supported over the longer term. A climate advocacy group said the extra coal capacity will add to half of the world’s emissions. The government is reviewing applications with BHP, and Glencore on the list.
Australia’s economy has remained resilient despite the global growth slowdown; however the Aussie currency has continued to lose out, and be pressured by the resilient dollar strength, with the USD index moving to 20-year highs and rising 5% since the Fed’s hawkish Jackson Hole speech on August 26. Also keep in mind, Australian economic data; Australian retail sales out tomorrow (Wednesday 28 September) and private sector credit (borrowing) out Thursday 29 September, are both expected to fall. Although the AUDUSD faces further pressure over the medium term, the AUDGBP is perhaps a pair to watch, after hitting six-year highs on the back of the UK’s tax cuts announced. What also supports this pair rising is Australia’s surplus continuing to trade at record highs, vs UK’s deficit likely to widen. Given that’s likely for now, the AUDGBP is a worthy pair to watch that could extend its uptrend.
The PBOC imposed a 20% risk reserve requirement on commercial banks’ foreign exchange forward sales to their clients. The move requires banks to set aside a 20% reserve of any forward sale of foreign currencies to their clients, including importers who seek to hedge their FX exposure. As banks will pass along the now higher funding costs of these FX forward transactions to their clients, it is estimated that it will be about 600 to 700 pips more expensive for banks’ clients to hedge their FX exposures for 12 months. The PBOC did use the same tool before in 2015 and 2018 and triggered some selling in USDCNY but did not reverse the depreciating trend then. PBOC’s move on Monday failed to halt the weakening in the onshore and offshore Yuan in the midst of a super-charged strong dollar against major currencies, with USDCNH rising by 0.4% to 7.17.
So far this year, out of the five biggest US firms by market value, Tesla has become the new megacap unlikely rival to Apple. Tesla shares are outperforming Microsoft, Alphabet, and Amazon so far this year, and coming close to Apple’s performance. However, Tesla’s shares are by far the most expensive. For more on what to expect from Tesla ahead, it’s worth reading or watching our update, available here.
Apple has begun assembling some of its iPhone 14 in India. This may be the start of a manufacturing boom in India, as China transitions to a consumption economy and US-China tensions continue to play out. Meanwhile, India’s push on electronics manufacturing could mean more foreign investments to come, as India seeks to solidify its position in global supply chains in addition to being a large consumption-driven economy. Our India equity theme basket is worth considering as India remains one of the big winners of deglobalization and slowing Chinese economy. Separately, also consider Apple is one of the most traded stocks at Saxo globally this month. We wrote recently on why to expect Apple to perhaps pave out a bullish sales outlook, for more read here.
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