Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equities closed in gains on the back of strength in technology, as well as a slew of strong bank earnings pushing financials higher. ECB officials, primarily a known hawk Klass Knot, started to turn dovish resulting in a plunge in German yields, but US retail sales data remained mixed later. RBA minutes and higher than expected NZ Q2 CPI still unlikely to support the procyclical currencies. Crude oil jumped higher on Russia supply concerns while Gold was back higher to test $1980.
Equities extended their advance higher, with the S&P 500 gaining 0.7% to 4,554 and Nasdaq 100 rising 0.8% to 15,841, led by strong performance in the information technology, financials, and energy sectors. Microsoft (MSFT:xnas) up 4% and Nvidia (NVDA:xnas) up 2.2% were among the top winners in tech. In financials, banks surged on earnings beats. Charles Schwab (SCHW:xnys) soared 12.6% while Morgan Stanley (MS:xnys) surged 6.5%, both helped by upbeat full-year guidance. Bank of America (BAC:xnys) rose by 4.4% on an earnings beat. The SPDR S&P Regional Banking ETF (KRE:arcx) surged 4.3%.
Treasuries had a choppy session on Tuesday as the market rallied, with the 10-year year falling as much as 6bps due to a rally in German bunds on dovish comments from ECB Governing Council member Klass Knot. The price actions however revered in New York afternoon as traders digested the mixed retail sales data and the risk-on sentiment in equities. The 2-year yield finished 2bps higher at 4.77% while the 10-year pared initial gains to close only 2bps lower at 3.79%. The 2-10-year curve flattened 4bps to -98.
After returning from a market closure due to a typhoon, Hong Kong stocks tumbled, driven by declines in technology and property names. The Hang Seng Index dropped by 2.1% and the Hang Seng Tech Index declined by 2.4%. The mixed bag of GDP and activity data from China yesterday was weak enough to trigger the downward revision of growth from some investment banks on the Chinese economy but not bad enough to bolster hope for more aggressive stimulus measures from the Politburo meeting later this month.
China Evergrande (suspended) announced that the distressed developer lost a total of RMB 582 billion in 2021 and 2022 and the total liabilities sat at RMB2.44 trillion at the end of 2022. Shares of Chinese property names tumbled on the news. Longfor (00960:xhkg), Country Garden Services (06098:xhkg), and Country Garden (02007:xhkg) plummeted between 8%-10%. In the tech space, Tencent (00700:xhkg), JD Health (06618:xhkg), SenseTime (00020:xhkg), Bilibili (09626:xhkg), and JD.COM (09618:xhkg) led the decline, falling between 4%-6%.
On the other hand, EV makers gained. Li Auto (02015:xhkg), XPeng (09868:xhkg), and BYD (01211:xhkg) climbed around 1%-2%. BYD Electronics (00285:xhkg) surged 6.1% after the electronic components manufacturer said its net profits for H1 were likely to be more than doubled. Another industrial name, Techtronic (00669:xhkg) also bucked the market decline to climb 2.5%.
In the A-share market, CSI300 shed 0.3%, driven by telecom, computing, and media. Northbound flows recorded a net selling of RMB1.2 billion, the largest outflow in nearly two months.
The US dollar whipsawed on mixed US economic data even as the EUR was weaker on central bank comments. EURUSD retreated from 1.1276 highs to 1.1230. NZDUSD reversed overnight weakness which took it to lows of 0.6260 to pop above 0.63 on firmer than expected Q2 CPI report this morning but reversed slightly subsequently. RBA minutes out yesterday hinted at further tightening may be needed but it wasn’t enough to push AUD higher which continued to trade just above 0.6800. Canadian CPI came in softer than expected at 2.8% YoY from 3.4% previously but firmer oil prices brought USDCAD from highs of 1.3243 to 1.3170.
While demand concerns continue to underpin, weakness in supply and signs of market tightness are also becoming key for oil traders. Russian exports for seaborne crude dipped to 6-month lows in the latest data, suggesting Russia may be making good on its threats to reduce supply. Crude loadings are down sharply at three Russian western ports averaged 1.78mb/d in the four weeks to 16 July, according to ship tracking data. Russia’s Energy Ministry said it will reduce its Q3 export plans by 2.1mt, or 500kb/d in August. WTI rose over 2% while Brent was up 1.4%.
After a less convincing run higher last week despite a breakdown in the dollar, Gold finally made strides to get back to key $1980 level yesterday on dovish ECB commentary hinting at policy options being open after the July rate hike.
The retail sales report came in mixed, reaffirming that the economy may be weakening as a result of the tightening policy but there are still no signs of panic. Headline retail sales rose 0.2% MoM, weaker than 0.5% expected but the prior month print was revised higher to 0.5% from 0.3%, offsetting some of the downbeat headline. Core (ex-auto) also missed expectations at 0.2% (vs. 0.3% expected) while supercore (ex-auto and gas) was as expected at 0.3% MoM. The control group, that feeds into GDP, saw a notable beat at 0.6%, above the expected 0.3% and prior 0.3%, matching the top end of analyst forecasts possibly on one-off online sales jump. Meanwhile, industrial production was much weaker than anticipated in June and fell 0.5% MoM (exp. 0.0%), outstripping the previous decline of -0.2%. This continued to suggest weakness in the manufacturing sector.
Reports suggested that ECB officials are considering communication about what will happen after the July 27 rate hike as their biggest challenge. They are keen to avoid any strong signals of either another hike or a pause. ECB's Knot, a usual hawk, commented that a hike in July is a necessity and that hikes beyond July are possible but not a certainty. Knot also commented that they could have hit an inflation plateau and that more tightening shifts the balance of risks towards too much, while he added that the 2% 2024 inflation view is optimistic.
BoJ Governor Ueda said there is still some distance to sustainably achieving the 2% inflation target and that the BoJ has been patiently maintaining easy policy, while he added that unless the assumption on the need to sustainably achieve 2% target changes, the narrative on monetary policy will not change.
New Zealand’s Q2 CPI slowed down from Q1 as it came in at 6.0% YoY from 6.7% earlier but was higher than the 5.9% expected. On a QoQ basis, inflation was at 1.1% from 1.2% previously and 0.9% expected. However inflation was below RBNZ forecast, suggesting little need for another rate hike. NZD popped on the report to rise above 0.63 but gains may not be sustainable.
Bank of America reported strong Q2 EPS of USD0.88, surpassing consensus of USD0.84. Net interest income was in line with expectations while fee income trends and operating margins were better than expected. Fixed-income and equity trading results also came in strong.
PNC Financial added 2.5% despite cutting net interest income and revenue guidance for 2023. On the other hand, Western Alliance declined 3% as the regional lender’s interest expense jumped 25% from the previous quarter and more than 8-fold from a year ago quarter.
Today’s focus on earnings will be on Tesla (TSLA:xnas) and ASML (ASML:xams). While Tesla has been extremely successful and executed beyond expectations for many years, the current valuation demands that Tesla deliver high double-digit revenue growth in the next ten years, as per Peter Garnry's analysis here. For Q2, the consensus estimate, as per the Bloomberg survey, projects revenue to grow at 45% Y/Y, reaching USD 24.54 billion, and the adjusted net income to grow 33% Y/Y to USD 2.87 billion. Investors will also pay close attention to the EV giant's delivery and revenue outlooks.
The results from the Dutch semiconductor equipment maker ASML (ASML:xams) will provide investors a glimpse of global demand and outlook for semiconductors, with significant investment implications much beyond these two companies.
Sterling was up 2% against the US dollar last week, but weakened against the EUR. Wednesday’s UK CPI report for June will be a key input for Bank of England’s August rate hike decision and the next big test for GBP strength. Headline CPI is expected to cool to 8.2% YoY from 8.7% previously, while core is expected to be firm at 7.1% YoY after an unexpected advance last month. If core drops below 7%, expectations of a 50bps rate hike at the August meeting could be downplayed, which could bring GBP downside. But wage metrics have remained strong, and another higher-than-expected core CPI print could bring volatility in Gilts and sterling.
As per Bloomberg, the Biden Administration’s upcoming new investment restrictions on China will be restricted to semiconductors, quantum-computing, and AI sectors and will not take effect until 2024.
China’s Zhejian province announced that it will relax the restrictions on household registration, or “hukou” system except for Hangzhou, the province’s capital city. The relaxation of the hukou system that discriminates against unregistered residents aims for enhancing common prosperity.
The Ministry of Commerce, together with 12 other ministries jointly rolled out measures to call on corporate and local governments to promote home improvement consumption.
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