Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Perhaps reality set in that markets could perhaps have been a bit too euphoric after just one inflation print showed CPI had dropped. Investors took profits from the Nasdaq 100 and S&P 500 seeing the indices fall 1% & 0.9% ahead of US PPI and following Fed officials’ remarks about ‘additional work to do’ and “a ways to go” to bring down inflation. Inflation expectations in a New York Fed consumer survey increased. Crude oil took a haircut, falling 4.2% after OPEC cut its oil demand outlook. Despite the US dollar rising against almost all major G-10 peers, The Aussie dollar nudged up to 0.67 ahead of the RBA meeting minutes.
Perhaps reality set in, that markets could perhaps have been a bit too euphoric after just one inflation print showed CPI had dropped. The major US indices snapped their two-day rally because US Federal Reserve speakers raised the alarm that the Fed had extra work to do to bring down inflation. Fed Governor Christopher Waller warned that “the market seems to have gotten way out in front over this one CPI report” and the Fed has “got a ways to go”. Adding to that, Fed’s Vice Chair Lael Brainard said there is “additional work to do”. Putting it into perspective, the S&P500 has still managed to hold onto a gain of 10% from October 10. Given the rhetoric of ‘more work to do’ has been reinforced, it’s important to remember bear markets produce wild swings in markets, and volatility might be expected to pick up given the uncertainty. Ten of the 11 sectors of the S&P 500 declined with Real Estate, Consumer Discretionary, and Financials falling the most and Health Care being flat. Amazon (AMXN:xnas) dropped 2.3% as the company announced plans to layoff about 10,000 employees. Tesla (TSLA:xnas) declined 2.6% as Elon Musk said he had too much work to juggle and was running Tesla “with great difficulty”. Toll and board games maker, Hasbro (HAS:xnas) tumbled nearly 10% on analyst downgrades.
Hang Seng Index climbed 1.7% and CSI 300 edged up 0.1% on the news that the People’s Bank of China and the Banking and Insurance Regulatory Commission jointly issued a notice to financial institutions with 16 measures to address the liquidity squeeze faced by property developers through measures including the temporary relaxation of previously imposed redlines restricting banks from lending over certain ceilings to developers and calling for financial institutions to treat private enterprise developers equally with state-owned enterprises. Leading China private enterprise property developers listed in Hong Kong soared, with Country Garden (02007:xhkg) jumping 45.5% and Longfor (00960) surging 16.5%.
US treasury yields rose about 6bps across the curve, paring some of the post-CPI gains, after returning from a long weekend, with the 10-year yield rising to 3.86% and the 2-year yield back to 4.39%. Hawkish comments from Fed Governor Waller that the market has gotten too much ahead of itself on one CPI report and there is still a long way to go triggered selling in treasuries during Asian hours. To add to that, the usually dovish Fed Vice Chair Lael Brainard said there is additional work to do in fighting inflation. Higher inflation expectations from the New York Fed’s Survey of Consumer Expectations weighed on the bond markets. Median one- and three-year-ahead inflation expectations increased to 5.9% and 3.1% from 5.4% and 2.9%, respectively. The median five-year-ahead inflation expectations rose to 2.4% from 2.2%. Also weighing on the markets during the session as about 12 billion corporate bond issuance.
The biggest bank in Australia and the second biggest company on the ASX, Commonwealth Bank (CBA) reported its financial results today, with the bank reporting its net profit after tax (NPAT) from continuing operations grew just 2% compared to the prior quarter to A$2.5 billion. Its common equity Tier 1 ratio fell slightly to 11.1% vs. 11.5% q/q (showing its holding slightly less cash), and it also declared a loan impairment expense of A$222 million from bad debts, (showing Australians are feeling the pinch of the rate hikes). All in all, CBA’s income rose 9%, driven by higher margins and volume growth, which partly offset the reduced non-interest income. Meanwhile, CBA’s expenses rose, 4.5% (excluding remediation) with higher staff costs adding to the bill. CBA’s shares have risen 21% from their June low. And the technical indicators on the monthly chart suggest its slow grind up could perhaps continue, but the monthly and daily charts look somewhat mixed/choppy- it guess you could say, showing volatility may pick up. A lot can be taken by the RBA’s commentary, which has alluded to insolvencies rising up. Which we can see has been reflected in CBA’s results. Also remember the RBA said that the rate hikes from May have not fully been felt by Australians yet. That means, CBA’s margins could remain thin given inflationary pressures and rising rates. If you are looking for alpha, we still believe commodities offer the most potential over banks.
WTI crude price fell 4.2% as OPEC cut its global oil demand outlook down 0.1million bpd to 99.6 million bdp for 2022 and down 0.1 million bdp to 101.8 million bdp for 2023. In the natural gas market, Freeport LNG will likely extend an outage that began in June, curbing the much-needed supply to customers in Europe and Asia.
Despite the US dollar rising against almost all major G-10 peers, the Aussie dollar has held its ground, thanks to fresh China stimulus (with China announcing a property sector rescue package, as well as relaxing some Covid restrictions). This has added to the AUDUSD rally, with the pair now gaining 6.2% this month, in anticipation that Australia’s trade surplus will bolster, with hopes that commodity demand will improve. In its minutes released this morning, it shows that the RBA considered the case for a 50bp rate hike but settled at raising 25bps as the RBA was mindful of the full impacts of prior hikes were yet to be fully felt.
In the October CPI released last week, a decline in health insurance costs due to technical factors contributed to the deceleration in the service component of the core CPI. In the calculation of core PCE, which the Fed watches most closely, the healthcare services prices are estimated from the PPI dataset than the CPI database. As a result, investors are likely to pay more attention to the October PPI numbers scheduled to release on Tuesday than usual as they are trying to gauge the trend of the service component of the core CPI. Bloomberg consensus estimates for headline PPI are +04% M/M and +8.4% Y/Y and for core PPI are +0.3% M/M and +7.2% Y/Y.
The 3-hour long meeting between President Biden and President Xi on the sidelines of the G20 Summit in Bali showed some goodwill gestures from both sides. Nonetheless, key issues remain unresolved. In a relatively conciliatory tone, the two leaders agreed to resume talks on climate change and economic issues between officials of the two countries. U.S. Secretary of State Blinken plans to visit China early next year.
Japan reported Q3 GDP that unexpectedly declined by 1.2% on a seasonally adjusted annualized basis, contrary to the consensus expecting a 1.2% growth. Falling net exports and a decline in housing investment drove the weakness.
October retail sales in China are expected to decelerate to +0.7% Y/Y according to the Bloomberg survey from +2.5% Y/Y in September as the surge in COVID cases and pandemic control restrictions took their toll on consumption. Industrial production is estimated to slow to +5.3% Y/Y in October from +6.3% Y/Y in September, amid Covid-related restrictions, slower auto production, and weak exports.
Home Depot (HD:xnys) and Walmart (WMT) are scheduled to report Q3 results today. Investors will be monitoring the top-line growth figures and assessment of business outlooks to gauge the state of US consumers.
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