Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equity markets continued higher in Europe yesterday as US markets were closed, Asian stocks were mixed and down from the highs intra-session in many cases as global crude oil prices continue to soar with sharp fresh price gains overnight in the wake of new EU bans on Russian imports. Rising oil prices risk sapping the bullish momentum and US treasury yields have jumped in overnight trading, adding possible further headwinds after the recent sharp market squeeze higher.
Nasdaq 100 futures rallied to 12,883 before meeting resistance pulling back to the 12,745 level this morning indicating a potential short-term headwind. Unless the Nasdaq 100 futures close below Friday’s close 12,678 then there is still room for hitting 13,000 in the short term. The news flow is light given yesterday’s holiday in the US, but trading is back today, and Fed’s Waller suggested yesterday that he favours 50 basis points hikes for several meetings suggesting financial conditions are not tight enough relative to the perceived inflationary pressure in the economy.
The two indices continued to rally on reopening and recovery prospects as Shanghai will go ahead and lift the lockdown tomorrow except for high/medium risk areas. The opening includes orderly resumption of public transport as well as private vehicle transport and allowing movements in and out of residential compounds. Residents are required to do regular PCR tests every 72 hours. The National Development & Reform Commission (NDRC) and National Energy Administration released an action plan on new energy development yesterday. Chinese new energy and electric utility names surged 3% to 13%.
Our outlook for sterling is one of the least favorable among G10 currencies as the UK is beset with massive external imbalances, aggravated over the last several months by the spike in energy prices. As well, the UK economy is severely supply-side constrained and will likely prove one of the first economies to tilt into recession in this cycle, with a Bank of England that is generally reluctant to hike aggressively due to the fears for a cost-of-living crisis and recession incoming. Recently, the GBPUSD has backed up sharply from below 1.2200 to all the way above 1.2600 but is finding resistance just above that level and well below the huge 1.3000 area. If the recent squeeze in risk sentiment rolls over to new concerns for the general outlook for global markets, GBPUSD may roll over for a retest of the cycle lows and perhaps beyond toward the 1.2000 level.
The Aussie is getting a boost from a combination of hopes for Chinese growth resurgence on the news that free movement has resumed in Shanghai and as the fresh jump in oil prices is pulling focus back to commodity markets, but the strong comeback from the lows in AUDUSD below 0.7000 may be challenged soon if the rise in oil prices drives concerns for risk assets and eventually, the global growth outlook. Already, the USD has rallied a bit from support elsewhere from yesterday’s lows as US yields have come back higher after yesterday’s US holiday. An important resistance level for the AUDUSD pair is the 0.7260 area, which is near the 200-day moving average and a pivot high from early this month. For a rejuvenation of the bearish case, A sharp sell-off back below about 0.7125 support would go a long way.
Crude oil trades higher for a ninth day after EU leaders agreed on a partial ban on imports of crude oil from Russia while China’s reopening has raised the prospect of recovering demand from the world’s top importer. Both WTI and Brent look set for a sixth consecutive monthly gain, and a near 90% gain during this time. The tight supply of refined fuels meanwhile has pushed prices of gasoline and diesel up by 103% and 123% respectively. The EU ban will immediately cover more than 2/3 of oil imports (1.6 million barrels a day), and with Germany and Poland saying they will cut pipeline supply; the impacted oil would exceed 90% by year end. The ban would force Putin to sell his oil in Asia instead at a sharply discounted price, currently around $35/b below Brent. OPEC+ meets on Thursday to rubberstamp another illusive 430k barrels per day production increase. The group has fallen well behind its own target with several countries, led by Russia, struggling to reach their quotas.
Gold once again failed to challenge key resistance at $1868/70 after a spike in US Treasury yields, a recovering dollar, and another risk-on day in the stock market hurt sentiment towards the safe-haven metal. The recovery has yet to show enough strength to challenge those looking for lower gold prices, hence a continued focus on economic data, the dollar and yield developments. Key support being an area between $1841 (200 DMA) and $1838 (38.2% of the recent recovery)
US treasury yields jumped higher overnight on the reopening of US futures markets after the Monday holiday, suggesting that the recent low-energy trading sessions bottoming out for the 10-year Treasury benchmark yield just above 2.70% area are an important resistance area for the recent treasury market consolidation. Focus for treasury traders will now shift to the impact of the Fed’s balance sheet reduction, or QT, that is set to kick off tomorrow, as well as whether inflation may prove stubbornly high and require more Fed tightening. Important US data for the balance of the week, including the ISM Manufacturing survey up tomorrow and ISM Services survey up Friday after the May jobs report will also weigh in the mix. The May 9 cycle highs in US treasury yields of 3.20% fell just a few basis points short of the late 2018 high.
Real estate volume down 60% in Sweden. Fresh data by Pangea suggests that higher financing rates is causing increased uncertainty over pricing and deals. The sector’s market value is about 40% GDP and the Riksbank is becoming worried over falling activity and potentially prices as it could cause credit agreements to be violated.
May inflation prints in Germany and Spain have come in above expectations. Germany’s May HICP inflation jumped to 8.7%, beating consensus forecast of an 8.1% increase mainly as food prices jumped higher. Spanish inflation was also higher at 8.5% vs. a consensus estimate of 8.3%. This adds upside risk to the outlook for euro-area inflation of 7.6% in May and will likely reinforce the European Central Bank's resolve to lift rates, possibly at a more aggressive pace than previously hinted.
Fed Governor Christopher Waller said he “supports tightening policy by another 50bps for several meetings”. His remarks hinted that he is not taking 50bps hikes off the table until inflation comes down closer to the 2% target, which suggests more than two 50bps rate hikes. Fed also begins QT tomorrow which adds another layer of uncertainty to the markets.
Official manufacturing PMI came at 49.6 in May, beating street consensus (Bloomberg survey 49) and bouncing 2.2 points from April’s 47.4. Non-manufacturing PMI rose to 47.8 in May, well exceeding the market expectation at 45.5 and 41.9 in April. Although both are still in contractionary zone, the rebound was board based. Large enterprises led the recovery in manufacturing PMI with the index back to expansionary zone with a 51.0 print. Among non-manufacturing activities, the construction sub-index moderated to 52.2 from 52.7 in the previous month while the services sub-index bounced to 47.1 in May from 40.0 in April.
Due to Shanghai’s lockdown which started from late March onwards, up to 260,000 twenty-foot equivalent units (twenty-foot-long containers) could not leave the port of the city in April. This will take weeks to ship, perhaps between eight to ten weeks. Neighboring ports are congested too. This is the case of the port of Ningbo-Zhoushan (busiest port in the world in terms of cargo tonnage) where many containerships have been diverted away from Shanghai in recent weeks. Expect the situation to worsen in the short-term as a new wave of Chinese exports looms with the reopening of the economy.
The recent relief rally, and arguably squeeze, in global equity markets was driven in part by excessive bearish sentiment, but also as the narrative has developed that we may have reached peak inflation for now after the April US Core PCE inflation came in line with expectations on Friday and sharply lower from the March peak, in part on base effects from the prior year. As well, US yields and Fed tightening anticipation have eased lower this month, for short rates on May 4 after Fed Chair Powell pushed back against the idea the Fed could hike by more than 50 basis points, and for longer US treasury yields a few days later, helping in turn to take the US dollar lows as well from a peak just before mid-month. And yet, here we are with global crude oil prices jumping aggressively to new highs and set for the Fed to actually begin balance sheet tightening (QT) tomorrow, with a ramping up of to a pace of $95 billion/month over the next three months.
The meeting is to discuss the state of the US and global economy, especially as inflation remains a key concern ahead of the mid-term elections and as US gasoline prices are set for fresh records in the wake of the most recent sharp rises in crude oil prices.
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