Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Despite Powell’s relative silence on policy outlook, there were other Fed and non-Fed speakers that continued to sound hawkish and raising alarms on inflation. Bonds slumped although equities and USD struggled to find direction in pre-US CPI positioning moves. Some optimism seen on European growth outlook while the World Bank still cautious about a global recession. Australia’s November CPI was hotter-than-expected, aiding further gains for the AUD which is underpinned by China’s reopening and policy stimulus.
After two Fed speakers reminding markets US rates could rise to over 5%, JPMorgan CEO Jamie Dimon joined the party, saying there’s 50% chance rates could go to 6%, while money managers BlackRock and Fidelity (among others) warned that markets are underestimating the ultimate rate peak. The World Bank slashed growth forecasts in half, saying new adverse shocks could tip the global economy into a recession. It estimates GDP will rise 1.7% this year, (that’s almost half the pace forecast in June). So this sets the stormy tone for the major indices in 2023. That said, JPMorgan's trading desk says there a two-in-three chance Thursday’s inflation data for December (released on US Thursday), could be on the soft side and spark a 1.5-2% S&P500 rally. On Tuesday the major US indices rose in choppy conditions; the Nasdaq 100 (USNAS100.I) rose for the third day, adding 0.9%, edging closer toward its 50 day moving average, the S&P 500 (US500.I) fluctuated around 3,900, which is a possible technical key resistance level. Others signs of caution were see in bonds, as the two-year US Treasury yield rose to 4.25%, the 10-year jumped 9 bps to 3.62%, while gold nudged up, to 8-month highs, $1,881, while the US dollar advanced modestly. Ten of the 11 sectors within the S&P 500 gained on Tuesday, led by communication services, consumer discretionary, and materials. The only sector that declined was consumer staples.
Fed Chair Powell’s speech did not have much impact on Treasuries as he did not discuss U.S. monetary policy specifically and only noted generally “restoring price stability when inflation is high can require measures that are not popular in the short term”. Yields on Treasuries rose as European government bonds sold off on supply from Italy and Belgium and ahead of today’s supply from Germany. Yields on 10-year bunds rose 8bps. Traders also sold Treasuries going into the auction of USD40 billion 3-year Treasury notes, bringing yields to the intraday high right before the auction. The 3-year auction went well with strong demand and saw Treasury yields off their intraday highs afterward. Yields on the 2-year finished the session 4bps higher at 4.25% and those on the 10-year were 9bps cheaper at 3.62%.
The Australian share market (ASXSP200.I) opened 0.7% higher, with other APAC markets expected to also open most higher. Japan’s futures suggest the Nikkei could rise the most across APAC today. But big picture, we think the most important thing for investor right now, is to consider, that… China’s economic recovery could be the dictator for the course of commodity assets, travel, and property. Not just China tech and consumer spending. China’s pivot away from its Covid Zero stance, led by a sooner-than-expected January 8 lifting of quarantines for cross-border travel, is poised to fast track its international air-transport recovery in 2023. But China’s recovery is not just about travel reviving. Chinese developers have also been seen kicking off recoveries in early 2023, having hit a bottom for contracted sales last year. As China’s economic recovery surges, stocks remain supported and are indeed rallying. A similar trend occurred in 2020 when mainland China reopened after a series of lockdowns following a breakout in Wuhan. But, reflecting on global trends, you’d think China has a better chance of putting Covid behind it this time around… which could support commodities and travel in particular. But, let’s see.
After a strong first week in the new year, Hong Kong and China stocks trod water on Tuesday. Hang Seng Index edged down 0.3% and CSI300 was nearly flat. Bilibili (09626) fell 4.3% after the company issued ADSs at a 7% discount to buy back convertible bonds. Chinese automakers rallied, especially EV names. Li Auto (02015:xhkg), Nio (09866:xhkg), and XPeng (09868:xhkg) surged each surged over 6%. BYD (01211:xhkg) pared all its initial weaknesses following the news that Berkshire Hathaway had reduced its stake to 13.97% from 14.06% and gained 2.9%. According to its CEO, Li Auto’s Model L7 is gaining market shares from Tesla’s Model 3 and Model Y. BYD reportedly will raise the prices of its EVs, as opposed to Tesla’s price cuts in China. Social media stories speculate that some Chinese cities are going to relax passenger car licensing restrictions in order to boost consumption. Shares of Geely (00175:xhkg) were up 6%, GAC (02238:xhkg) +3.1%, and BAIC (01958:xhkg) up 2.2%. Macao casino operators outperformed with Sands (01928:xhkg) rising 4.8%, MGM (02282:xhkg) up 3.6%, and SJM (00880:xhkg) up 3.1%. In A-shares, automakers, retailing, electric equipment, and beauty care names gained while financial, petrochemical, and steeling makers were among the biggest losers.
Lack of data and anu relevant commentary from Fed Chair Powell left the USD struggling to find direction in the pre-CPI trade. EURUSD was the outperformer, with better growth outlook underpinning, but it continued to find resistance at 1.0760. USDJPY is back above 132 amid higher yields, while AUDUSD rose back above 0.69 following the higher-than-expected November CPI. USDCNH also still below 6.7900.
The Aussie dollar rose 0.3% to 0.6911 US, with inflation and retail sales coming in hotter than expected, which shows the RBA has room to keep rising rates, and as such this theoretically supports the AUD. Core or trimmed CPI (which the RBA looks at) rose from 5.3% YoY to 5.6% YoY in November - hotter than 5.5% YoY expected. Retail sales rose 1.4% in November, beating the 0.6% expected, while also importantly showing Aussie retail sales strongly recovered from the October drop in sales. Some traders have a view the Aussie dollar will push up over the medium term, in lieu of China’s reopening notion which is likely to add to Australia’s GDP, with hot sauce coming from China buying Australian coal for the first time in two years.
Crude oil prices wobbled on Tuesday as the market remained buoyed by optimism of China demand recovery. European session was supported by upbeat Eurozone outlook. Meanwhile, EIA raised its forecast for demand growth in 2023 to 1.05mb/d. However, it also expects US output to rise to meet this demand, with US shale oil providing the bulk of the gains. The API report showed a strong inventory build of 14.9mn barrels in crude as against expectations of a 2.2mn draw, and focus now turns to EIA figures today. WTI futures touched $76/barrel before sliding back below $75, while Brent reversed from $81.
Copper continues to get support from China’s reopening and policy support to fuel economic recovery. Gains were further boosted by Chair Powell staying away from a pushback on easing financial conditions, and the weaker USD as a result. Having retraced close to 50% of the 2022 sell off, HG copper is now seeing resistance ahead of $4.08 (LME $8900), potentially opening up some scope for a correction to check the strength of support. Focus in that regard being $3.84, the 200 DMA, the break above which started this latest runup.
With some expectations that Powell would likely pushback on the easing financial conditions, equity markets celebrated the lack of any clear guidance on policy direction. Fed Chair Powell did not comment on the current US economic or monetary policy outlook in his prepared remarks, only stating that restoring price stability when inflation is high can require measures not popular in the short term. The pushback on market’s rate cut expectations from Kashkari (voter) was more direct, saying that "They are going to lose the game of chicken." Bowman, also a voter, was also relatively hawkish with comments hinting at more work to do on inflation. When a sufficiently restrictive rate level is reached, the Fed needs to hold the policy rate there "for some time".
Softer energy prices, the lack of black-out and resilient hard data (notably in Germany) are pushing forecasters to review their 2023 recession calls. Goldman Sachs is the first international bank to drastically revised upward its growth forecasts, from minus 0.1 % in 2023 to 0.6 %. Said differently, the U.S. based bank does not expect a recession in the eurozone this year anymore. Early Q4 indications are out this Friday with the preliminary 2022 FY growth estimate. This should certainly confirm a milder-then-expected economic downturn. A mild recession (meaning drop in GDP of 0.1 or 0.2 %) is still our baseline this year. But we agree that the economy is surprisingly resilient. We also believe there will be no extreme macro and market events in 2023 – which could be positive from a growth perspective. If the economy performs much better, this will however give ECB policymakers more confidence in hiking rates as laid out in December by Christine Lagarde.
The World Bank cut its global growth forecast to 1.7% this year, down from an estimate of 3.0% in June. This marks the third weakest pace of global growth in nearly 30 years, overshadowed by only the 2009 and 2020 downturns. Growth estimate for 2024 was also slashed, down to 2.7%, as persistent inflation and high interest rates weigh. Meanwhile, the agency urged for global action to mitigate the risks of a global recession and debt distress.
In December, the growth of outstanding aggregate financing, the broad measure of credit in China, decelerated to 9.6% Y/Y from 10.0% Y/Y in November. New aggregate financing declined to RMB1,310 billion in December (below consensus RMB1,850 billion) from RMB1,987 billion in November, dragged by a decline in new bond issuance from local governments and a net bond redemption by corporate. New RMB loans rose to RMB1,400 billion (above consensus RMB1,200 billion) from RMB1,214 billion in November and were also above RMB1,130 billion in December 2021. The growth of RMB loans picked up to 11.1% Y/Y in December from 11.0% in November. The better-than-expected growth in RMB loans was driven by new loans to the corporate sector which rose to RMB1,264 billion in December from RMB884 billion in November and above RMB 662 billion a year ago, as the Chinese authorities had asked banks to extend credits to support the housing market and other key industries. New loans to households came in weak, falling to RMB175 billion in December from RMB263 billion in November and RMB372 billion in December a year ago.
China’s Lunar New Year travel season started last Saturday 7 January with 9,454 flights or a 2.26% growth from the first day of the same travel season last year. The number of daily flights increased to 10,123 on 8 January, an 13.65% increase from the same period last year and above 10,000 for the first time since August 2022.
In retaliation to travel restrictions imposed on visitors from China, China stops issuing short-term visas for visitors from Japan and South Korea. Restrictions from both sides could be a temporary setback to the trend of the reopening of the Chinese economy but it is likely to be resolved in the near term.
Microsoft is reportedly in discussion to make an investment of USD 10 billion in Open AI, the creator of AI bot ChatGPT. This would be Microsoft’s second investment, after acquiring a USD1 billion stake in 2019. Microsoft is expected to integrate ChatGPT into the software giant’s search engine.
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