Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equity markets churned back and forth and closed mixed last week after the official US jobs report showed far more payroll gains than expected and US yields surged higher in anticipation of more rapid Fed policy tightening. This week, markets in China are back online after a long holiday, earnings season rumbles on and traders will have to mull the implications of the latest spike in oil prices.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - Friday’s session ended much better than feared in early hours of trading as Nasdaq 100 futures were pushing below the Thursday’s lows, but a late session rally pushed the Nasdaq 100 to a relatively strong close. This morning, Nasdaq 100 futures are trading around the 14,725 level which is above the 38.2% retracement level from last week’s highs. If US technology stocks push higher today the 50% and 61.8% retracement levels at 14,811 and 14,917 respectively are the key levels to watch. The VIX sits just above 23 indicating above average expected volatility with the forward curve sloping slightly upwards. While the earnings season is still ongoing, we do not expect a big impact any longer from earnings.
Hang Seng (HK50.I) traded lower in Asia led by internet, software, and catering stocks while oil and gas, coal mining, industrial mental mining, and infrastructure stocks were up. Alibaba (9988.HK) fell 3.7%; Meituan (3690.HK) was down 2.7%. In A-share markets, CSI 300 was up 1.6% in the morning session. Caixin Service PMI fell to 51.4 in January (down from 53.1) to its lowest level in five months. Passenger trips during the pre-holiday travel rush and during the holiday were still 64.6% and 68.8% respectively below the same period in pre-pandemic 2019. Tourism revenues were 3.9% and 43.7% below 2021 and pre-pandemic 2019 respectively. New home sales (by floor space) in 30 major cities were down 30.2% in January yoy. The top-100 developers’ sales (by value) were down 41% in January yoy.
EURUSD – the exchange rate surged higher last week as Thursday’s ECB meeting was seen as the “capitulation” meeting in which the central bank admitted that it would review its inflation policy in coming meetings and the market took this as nearly certain to mean a quick end to balance sheet expansion and. Most of the upside was due to the strong euro, not a weak US dollar and the rally held well Friday despite a very strong US Jan. employment report (more below). Still, it may be difficult for the pair to post further short term gains after the magnitude and speed of the rally off the cycle lows below 1.1150. Resistance is the major pivot high from late last year just ahead of 1.1500 and likely that big, round number itself, and first support is perhaps 1.1400, although the 38.2% retracement of the rally is all the way down at 1.1345.
USDCNH – the USDCNH exchange rate stayed relatively quiet last week during China’s long holiday week, but the PBOC surprised the market today by fixing the onshore CNY at 6.3580 to the US dollar, the weakest level relative to expectations in years. The week before last the bank seemed to send a signal by weakening CNY sharply just after it has posted new multi-year lows and this sends a further signal that the bank is not interested in allowing CNY and CNH to slip further against the US dollar.
Crude oil (OILUSMAR22 & OILUKAPR22) trades mixed following a week that saw prices hit the highest levels since 2014. US natural gas (NATGASUSMAR22) and WTI, however, trades softer, with a drop in the March-April WTI prompt spread to $1.6 from $2.2 on Friday signaling reduced supply risks as output returned after a winter storm swept across the South. Saudi Arabia raised its selling price to all corners of world for March, a signal they expect strong demand for its crude, not least considering the rising gap between OPEC+ quotas and what is and can be being produced. Focus on geopolitical developments as well as monthly oil market reports, starting with the EIA tomorrow, as the market seeks guidance on the supply and demand situation.
Gold (XAUUSD) once again managed to find a bid below $1800 on Friday after a stronger-than-expected US job report sent US 10-year yields higher while increasing the number of expected US rate hikes in 2022 to more than 5. Total holdings in bullion-backed ETFs dropped for a second day on Friday while hedge funds in response to the hawkish January FOMC meeting cut their net long in COMEX futures by 47% to a four-month low (COT update covering week to February 1). Silver (XAGUSD) has bounced after once again finding support at $22 and following a 58% reduction in the net futures long, a break above the 21-day moving average may trigger some fresh momentum buying. Gold resistance at $1817, the 21-day moving average and 50% retracement of the Jan 25-28 FOMC related slump.
US Treasury (IEF, TLT). Markets long await Thursday’s CPI numbers. However, tomorrow’s trade balance will also be crucial for bond investors. A larger trade deficit requires more foreign investors to buy US assets while more buyers are needed to fund the US budget deficit while the Federal Reserve ends its QT. That could drain demand from upcoming US Treasuries auctions. The US Treasury is selling 3-year notes tomorrow, 10-year bonds on Wednesday, and 30-year Bonds on Wednesday. To worry investors holding risky assets should be the 10-year auction, as yields broke above 1.9% on Friday, getting close to the pivotal 2% level.
EU Sovereigns (VGEA). In Europe, the focus will be on the European Commission economic forecasts, especially for a possible revision of inflation projections for this year and 2023. The market is focused still on last week’s hawkish ECB’s meeting, however rising yields in the US could force European peers higher. The biggest focus at the moment is the German Bund, and the BTPS-Bund spread as it could trigger another EU political crisis as it widens. We believe the breaking point will arrive when the BTPS-Bund spread gets close to 200bps. Although we are far from that, things can move quickly as volatility remains sustained and rates rise globally.
What is going on?
ECB’s Klaas Knot says appropriate to hike rates this year – the Dutch central bank governor is the first member of the ECB’s Governing Council to specifically state that interest rates should be raised this year, as he also argued that QE should be wound down as quickly as possible before hiking rates in Q4.
US Jan. jobs report far stronger than expected. On Friday, the market was looking for weak jobs growth for January after the ADP Jan. private payrolls tally reported an outright drop of 300k in payrolls earlier in the week. This took expectations to below 150k for the official nonfarm payrolls, with some banks expecting a negative number. Instead, the BLS reported growth of 467k and even more impressively, the Nov. and Dec. numbers were revised over 700k higher. The Unemployment Rate ticked up to 4.0%, but that was due to the participation rate normalizing another 0.3% higher (meaning the labor force grew and more workers began looking for jobs). The Average Hourly Earnings number rose 0.7% month-on-month and 5.7% year-on-year vs. 0.5%/5.2% expected, respectively, although average weekly hours worked fell 0.2 hours, skewing the reading somewhat higher.
Strong rebound of the UK January construction PMI. It was out at 56.3 versus prior 54.3. The UK construction sector is gaining momentum as commercial activity surged to a six-month high and supply chain disruptions are easing. This helped to offset a weak start of the year for house building.
Disappointing EZ December retail sales. They declined by 3 % month-over-month versus minus 0.5 % expected. This is a big miss. It seems that rising consumer inflation is starting to take a toll on consumer spending. This is also happening in the United Kingdom, for instance. In detail, retail sales of non-food products fell by 5.2 % and internet sales by 3.9 %.
What are we watching next?
Corporate credit spreads – with central banks lurching onto a more aggressive policy tightening path, the impact on corporate credit bears watching after a long period of remarkably generous conditions for corporate borrowers. Yield spreads have widened across the board this year, if modestly, with investment grade spreads in the US at their highest since late 2020, according to one Bloomberg index, while high yield spreads have yet to widen beyond late 2021 levels. The FT reports, however, that some bond investors are scrambling to hedge corporate bond holdings with credit default swaps (CDS’s) where the activity level rose in January to the highest since March of 2020. Corporate credit spreads are an important measure of financial conditions.
February Eurozone Sentix investor confidence is out this morning. In January, the index unexpectedly improved to 14.9 from 13.5 in December. Expect it will continue to move upward. The economist consensus forecasts the headline to reach 15.2. However, the expectations index is likely to remain subdued due to the continued effects of supply bottlenecks and high inflation figures.
Russo-Ukrainian crisis update. The French president Emmanuel Macron is flying to Moscow today to meet the Russian president Vladimir Poutine today. Tomorrow, he will be in Kyiv (Ukraine). He is trying to find a path to common ground from which to move forward.
Earnings Watch. Busy earnings week ahead with earnings focus today on Amgen and Tyson Foods. The Q4 earnings season shows that profit margins are under pressure from rising input costs across wages and commodities with the pressure being the biggest in the US.
Economic calendar highlights for today (times GMT)