Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: US PCE inflation data on Friday spooked the market as the Fed terminal rate for this year was taken higher still, with discussion of the risk of larger hikes even afoot. Both the US S&P 500 Index and Nasdaq 100 touched their 200-day moving averages intraday on Friday as yields jumped. This week’s focus still on geopolitical developments, faltering confidence in the China re-opening narrative and US Feb. ISM Surveys Wednesday and Friday, with the key US employment figures not up until next week.
US equities continued their decline on Friday with S&P 500 futures declined 1.1% to the lowest close since around mid-January as US inflation figures (PCE deflator) surprised to the upside. As we have explained in recent equity notes the equity market will be driven by the talk about structural inflation over the coming months and how that discussion recalibrates long-term US bond yields to higher levels. In late April and May when the Q1 earnings are released the discussion about margin compression will heat up again, so there are plenty of downside risks still in equities in 2023.
Hang Seng Index and CSI300 extended their declines with both indices falling around 0.4-0.5%. Investors trimmed positions as sentiment was dampened by resurge of tension between the U.S. and China over Russia and Ukraine and the lack of substantive recovery in the Chinese economy aside from credit expansion and survey data. China’s central bank emphasized in its Q4 Report on the Execution of Monetary Policy that the monetary policy must be stable and not bring about excessive liquidity that induces excessive investment, a surge in debts, and asset bubbles. Investors interpreted that as a signal to lower the expectations of the market on aggressive monetary easing. The CCP’s central committee is holding a meeting from 26-28 February to decide on the recommendation list of candidates for top government posts to be sent to the National People’s Congress to finalize during the latter’s meeting commencing from 5 March.
The dollar strength was back in focus as hot core January PCE inflation data on Friday took the repricing of the Fed’s path higher once again. With 2-year yields surging to their fresh highs, along with BOJ governor nominee Kazuo Ueda’s continued push for a loose monetary policy coming against market’s hawkish expectations, the Japanese yen plunged to its lowest levels this year, with USDJPY testing 136.50 overnight. Also worth watch will be AUDUSD which plunged in close sights of 0.67 as risk sentiment and commodity prices are taking a beating. Elsewhere, UK PM Sunak is making headlines with reports saying that he may have won big concessions in the looming Brexit deal, with reports suggesting that an agreement between the UK and European Union on Northern Ireland appears to be very close. UK PM Sunak and EU head Ursula Von Der Leyen will hold talks mid-day on Monday. These are being described as 'final talks'. This will be followed by a news conference and Sunak’s statement to the parliament. GBPUSD dropped below 1.20 with the 200DMA at 1.1928 in focus.
Crude oil remains anchored near the lower end of its the established range that has prevailed since the end of 2022, in Brent between $80 and $89, and WTI between $82 and $73. Overall, the sentiment across markets, including commodities, suffered another blow last week after traders and investors in response to another hot US inflation data increased forecasts for US interest rates. Higher rates may hurt economic growth and with that fuel demand from consumers. China meanwhile remains on a recovery track but for now it has only prevented an even deeper selloff in crude oil. A disruption in oil supply to Poland via the Druzhba pipeline from Russia, a day after Poland delivered its first Leopard tanks to Ukraine, is having a limited impact. Speculators meanwhile hold an elevated long position in Brent according to COT data released on Friday (see below). In focus this week, the annual International Energy Week which kicks off in London on Tuesday.
The US dollar reached a multi-week peak in the aftermath of hot US data and together with higher yields have weighed on the yellow metal, with gold risking further weakness towards the 200DMA at $1776 amid a tough macro environment. US ISM PMIs in focus this week, along with more Fed speakers, as a guide to high how interest rates could go. Silver (XAGUSD) fell harder, down 2.5% on Friday and closing with a weekly loss of 4.5%, breaking below the 200DMA at $21. The gold-silver ratio meanwhile has spiked to 87.80 high, a 16% underperformance relative to gold since mid-December.
With the US PCE data further aggravating concerns on Fed’s rate hike path and bringing the 2-year yields to fresh highs, base metals plummeted. Copper prices plunged to a seven-week low below the key $4 support with the next key support being the 200DMA at $3.77, the break above which triggered January’s surge. Incongruent signs of a pickup in Chinese demand also continue to underpin, and the PMI reports this week will be key to signal whether activity levels are picking up. However, with supply over time potentially struggling to keep up with demand, we view the current weakness as temporary and part of the general loss of confidence that has hit markets this month.
The hot core US January PCE inflation data released on Friday (more below) shocked US yields to new cycle highs, with the 2-year treasury benchmark yield reaching above 4.8% for the first time since 2007 as the market moved to completely price in at least a 25bp hike each at the March, May, and June FOMC meeting plus about a 25% chance that the hike in March is 50bps, bringing the terminal rate to 5.4. The Jun-Dec 2023 spread narrowed 11bps to -11.5bps, almost entirely eliminating expectations for rate cuts in the second half of 2023. Ten-year yields poked toward the recent cycle highs just shy of 4.00% and the 2-10 yield slope closed the week at a new multi-decade inversion record of –89 basis points (an intraday spike on Feb. 15 saw it briefly below –90 bps).
The PCE deflator for January came in hotter-than-expected, and together with upward revisions to the previous month’s prints these sent a strong hawkish signal to the markets reinforcing the Fed’s higher-for-longer message. The Core PCE rose 4.7% Y/Y, accelerating from the upwardly revised 4.6% and above the expected 4.3%. The M/M rose 0.6%, hotter than the expected and upwardly revised prior of 0.4%. This brought an upward repricing of the Fed path, with increasing calls for 50 bps at the March meeting and the terminal rate now priced in at 5.4% (82+ bps of further hiking from current level) and the end-2023 expectation at –12 bps relative to peak rates,
Fed voter Jefferson spoke about labor market strength on Friday, saying that ongoing imbalance between supply/demand for labour suggests high inflation may come down only slowly and said the argument that policymakers should accept that disinflation will be costly is well-reasoned. Bullard (non-voter) was on the wires again as well, and reaffirmed the need to move quickly to shield credibility. Collins, also a non-voter, said that recent US data affirms the case for more rate hikes. Mester (non-voter) said the Fed has to do "a little more" on rate hikes saying the new inflation data affirms the case for more rate hikes to get inflation back to target.
After threats from US about making public the information on China supplying weapons to Russia, China came up with a 12-point peace proposal on Friday to be a neutral mediator in the Russia-Ukraine conflict. Reports suggested that China’s proposal took a clear anti-West stance, condemning NATO extension and sanctions against Russia, but Ukrainian President Volodymyr Zelensky has signaled he's open to China's new ceasefire plan and meeting President Xi. How these events turn this week will be key to watch, especially US comments and support to Ukraine if it was to accept China as a mediator.
The ICE Futures Europe exchange released four weeks' worth of delayed COT data on Friday with reporting now up to date following the January cyber-attack on ION Trading UK, which caused delays in trades being reported. The US CFTC meanwhile released one COT report for the week ending January 31 with data unlikely to be up to date for another three weeks. ICE Brent data showed unwavering support for higher prices with funds holding a net long of 277k lots, a 16-month high and the weakest gross short position at 28k since 2011. The ICE gasoil (diesel) net long meanwhile dropped to 33.7k lots and lowest since November 2020. The futures contract (FPH3) trades near a one-year low with refinery margins under pressure as Middle East and Asian shipments replace supply from Russia.
One year on from the Russian attack on Ukraine which triggered a surge in wheat, corn and edible oils we a seeing prices continuing to deflate. Global wheat prices remain under pressure from a flood of Russian supplies forcing EU and US sellers to lower prices to stay competitive. In Chicago the soon to expire March wheat contract trades near a 17-month low, down 48% from the March 2022 panic peak while Paris Milling wheat has declined by 38%. The focus is turning to the outlook for global wheat crops this year. According to Bloomberg, US farmers are likely to plant more than analysts expect, and nearly all of France’s soft-wheat crop is in good to very good shape. Traders are also watching talks on the Ukraine grain-export deal, which is up for renewal in March.
Warren Buffett’s holding company Berkshire Hathaway announced over the weekend operating earnings of $6.7bn vs est. $7.3bn driven by weaker results in its railroad and insurance businesses due to higher input costs for materials and labour. Berkshire Hathaway is still striking a positive outlook on the US economy. Warren Buffett also talks about the repurchases saying that they are not all bad if they are bought below the fair value.
Following the theme of strong energy company earnings reports Woodside’s bottom line profits rose 228% fuelled by the rise of oil and gas prices, but also as Woodside output rose over 70%, after it acquired BHP’s oil and gas business. Woodside reported a larger final dividend of $1.44 per share, up from $1.05 a year ago. Its full year dividends payout stands at $4.8bn. On top of that, Woodside is now seeking opportunities to expand again narrowing in on potential buying assets in the Gulf of Mexico. Woodside’s record profit results follow a set of strong numbers from oil and gas producers including Shell, BP and Santos. This also sets the tone for energy companies in 2023. Woodside Energy shares ended 1.5% higher on Monday in Australia. Keep an eye on US and London listed Woodside.
This year’s Government Work Report will be delivered on 5 March. This will provide more details on policy action for urbanization and the property market. There will likely be two main points of interest: affordability (measures to increase accessibility to mortgage loans) and rural construction (focus on rural land transfers and reduction of complexity in regulation). With further stimulus measures in sight, we are confident that China will probably announce a higher GDP target at the upcoming National People’s Congress – meaning 5.5 %.
The recent data out of the US has shown firm inflation and growth dynamics, prompting an upward repricing of the Fed’s path and bringing yields to critical levels. The ISM surveys this week will be key to watch for further direction, with the manufacturing survey out on Wednesday and services out on Friday. The consensus is for the manufacturing ISM to improve to 48.0 in February from 47.4 in January, but still in contraction (below 50) for a fourth consecutive month. The ISM services index saw a surge to 55.2 in January after a drop to 49.2 in December, partially a reflection of winter weather trends. Gains are likely to moderate, and consensus expects 54.5.
China reopening theme is under strain, with the Asian reporting season underway, and this week brings earnings reports from two large EV manufacturers. Li Auto (02015:xhkg/LI:xnas) reported on Monday before China open while Nio (09866:xhkg/NIO:xnas) reports on Wednesday. It will be key to watch how Tesla’s steep discounts and the end of government subsidies impacts the outlooks for these two Chinese EV manufacturers which got off to a slow start this year, and whether the decline in lithium prices lifts the outlook higher. Tesla (TSLA:xnas) will hold an Investor Day event on March 1 in what could be one of the key days of the year for the electric vehicle giant. Nio, Li Auto and XPeng (09868:xhkg/XPEV:xnys) also report February deliveries this week, and China’s EV and battery giant BYD (01211:xhkg/BYD:xnys) should release February sales by Friday.
Oil and gas companies have again reported the best earnings growth this US and Australian corporate reporting season - with increased profits and higher dividends from Shell, BP and Santos. Occidental Petroleum’s outlook will be a focus today, as well as Canadian Natural Resources results later in the week. Occidental is expected to report its highest-ever Q4 net income, with the US energy giant set to benefit from high energy prices amid tight supplies. The oil and gas giant generated about $2.8bn in free cash flow in the period after years of austerity and debt reduction, according to Bloomberg consensus. Investors will closely monitor its 2023 spending and capital-returns outlook with adjusted EPS of $1.79 expected. Occidental's shares are down 6.6% this year.
Today’s key US earnings releases are Occidental Petroleum, Li Auto, and Zoom Video with a preview of Occidental Petroleum in the section above. Zoom Video will be watched as many retail investors still have a big interest in this pandemic winning company with analysts expecting FY23 Q4 (ending 31 Jan) up 3% y/y and EBITDA of $353mn up from $278mn a year ago. Li Auto is also in focus as the electric vehicle adoption continues to accelerate with Chinese production expected to expand more rapidly in 2023 as the zero-Covid policy has ended. Analysts expect Li Auto revenue growth of 66% y/y. The three other key earnings we are watching this are Salesforce, Snowflake, and Coupang which we highlight in our earnings watch note from last Friday.
1000 – Eurozone Feb. Confidence Surveys
1330 – US Jan. Preliminary Durable Goods Orders
1530 – US Feb. Dallas Fed Manufacturing Activity
1530 – US Fed’s Jefferson (Voter) to speak
1700 – ECB Chief Economist Lane to speak
2350 – Japan Jan. Industrial Production
0000 – New Zealand Feb. ANZ Business Confidence
0030 – Australia Jan. Retail Sales
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