Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: The selloff in regional bank shares weight on the market sentiment, seeing U.S. equities lower driven by weaknesses in financials, communication services, and energy. Euro took a brief look below 1.10 before recovering to 1.1020 subsequently after ECB downshifted to a 25bps rate hike. Apple bucked the challenging economic and industry environment with a solid beat in FYQ2 top lines and earnings on strong iPhone performance. Today’s focus will be on the U.S. employment report.
The selloff in regional banks weigh on the broader U.S. banking sector, seeing all 21 members of the KBW Bank Index, which includes the largest banks, in the red and the index declined by 3.8%. The S&P 500 shed 0.7%, driven by losses in financials, communication services, and energy.
Nasdaq 100 slid 0.4%. Advanced Micro Devices (AMD:xnas) surged 6.1% on the headline that the chipmaker is working with Microsoft (MSFT:xnas) in its expansion into AI processors. Apple Inc (APPL:xnas) gained 2.5% on revenue and earnings beat.
The 2-year yield swung widely after rising to 3.89% on a smaller-than-expected increase in jobless claims and a much hotter-than-expected growth of 6.3% in Q1 unit labor costs, before falling to as low as 3.65%, the lowest level since September 2022 on the stress in regional bank stocks and then finally finished only 1bp lower at 3.79%. Buying was mostly on the front end and the 10-year yield rose 4bps to 3.38%, steepening the 2-10 curve by 5bps to -41. SOFR 3-month interest rate contracts were well bid in the morning, with rates falling 30bps in the 2024 contracts before giving up some gains to finish 15bps lower in rate (higher in prices). The Dec 2024 SOFR (SR3Z4) last traded at 97.28 (i.e. 3-month interest rate at 2.72%).
Mainland China returned from the Labor Day holiday and had a muted response to a mixed bag of economic data. Similar to the official NBS manufacturing PMI released earlier, today’s Caixin China manufacturing PMI fell below the expansion-contraction threshold to 49.5. Trading in mainland A-shares was lacklustre and lacked directions, with CSI300 finishing the session nearly unchanged from last Friday before the long holiday. The Shanghai Composite Index advanced 0.8% while the Shenzhen Component Index declined -.57%.
The travel and consumption data for the five days during the 5-day holiday period indicated a strong pick-up in consumption but tourism, lodging, and catering stocks retreated sharply in mainland bourses. A-share financial names gained, with Cofco Capital (002423:xsec) and China Minsheng (600016:xsec) hit 10% limit up. A number of central-government-owned names in the infrastructure construction, materials and media space surged.
China financial names including insurance companies and banks listed in Hong Kong also outperformed notably, with Ping An Insurance (02318:xhkg) surging 7.7%, Citic (00267:xhkg) up 5.7%, China Life Insurance (02628:xhkg) up 5.2%, and ICBC (01398:xhkg) rising 5.1%. Hang Seng Index advanced 1.3%. Trading in technology names was relatively muted as Hang Seng Tech Index edged up 0.6%.
EURUSD took a brief look below 1.10 on Thursday, although recovering to 1.1020 subsequently, after ECB downshifted to a 25bps rate hike. While the door for further tightening was kept open, market expectations turned dovish as ECB is likely to eventually follow the Fed and a peak is coming. GBPUSD, meanwhile, continued to make attempts at a break of 1.26. Regional banking concerns still remain top of mind and USDJPY plunged lower to 133.50 before a rebound to 134.20 subsequently. NZDUSD was the strongest, having broken above 100DMA at 0.6279 which opens the door to 0.64.
Crude oil steadied after a fierce three-day selloff sparked by concerns of dwindling demand as banking concerns continue to send shivers. Brent crude has shed over 10% this week as weak PMI data in China, combined with ongoing tightening of financial conditions weighed on sentiment. Meanwhile, Saudi Aramco also lowered its official selling prices to Asian customers. WTI prices stayed below $70/barrel while Brent stayed below $74. Supply side is less of a focus for now. Russia reaffirmed its commitment to cut crude oil production amid signs of robust exports. However, supply concerns were offset by additional 1 billion barrel crude oil discovery onshore Turkey
Caixin China manufacturing PMI, which has a larger focus than the official NBS manufacturing PMI on export-oriented small and medium size enterprises in coastal China declined to 49.5 in April from 50.0 in March, back to the contraction territory. New orders, falling below 50, drove the deceleration in the headline PMI as demand weakened. Nonetheless, according to Caixin, the expectation about the future has improved from the level in March.
As widely expected, the ECB stepped down to a 25bps rate hike pace from the 50bps unveiled in March, bringing the deposit rate to 3.25%. While recent data has confirmed that underlying inflationary pressures remain sticky, especially for core, weak credit growth and the latest results of the Bank Lending Survey have indicated that the rate hikes so far are clearly leaving some stress on the financial sector of the economy. The ECB also announced that the reinvestments of its Asset Purchase Programme (APP) will be stopped in July, which could equal to a €25bn reduction of the portfolio on average every month as per their own estimates. However, it was later revealed as a deal between the hawks and doves to go ahead with the 25bp hike instead of 50bps. Lagarde emphasised at the press conference that “the inflation outlook continues to be too high for too long”, keeping the door open for further rate hikes.
While the job openings cooled and jobless claims in the US rose to 242k last week from 229k previously, the ADP survey on the other hand showed additions in jobs blowing past estimates. This suggests US labor market indicators have been mixed so far, and focus will be on the April nonfarm payroll which is scheduled for release today. Hiring pace is expected to slow, and Bloomberg consensus forecast is looking for it to come in at 185K in April from 236K in March, as layoffs extend from IT sector to banking and others, even as services sector continue to hire. Unemployment rate is also seen marginally higher at 3.6% from 3.5% previously, but wage pressures will likely still remain firm 4.2% YoY/0.3% MoM. The jobs report will be used to gauge the Fed's next move, whether that be a pause, or lead to some "additional policy firming", but it is worth stressing there is plenty of data between now and the June 14 FOMC, with what happens in the banking sector being more key at the moment.
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