Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: The U.S. markets reversed and turned south yesterday after a weak Conference Board Consumer Confidence survey, in particular the expectations element. Buying from quarter-end portfolio rebalancing has exhausted and gave way to selling from trading accounts. China relaxed quarantine requirements over inbound travelers but tourism stocks pared gains. Chinese auto stocks were pressured after an EV maker, NIO being alleged for accounting irregularities.
US equites appear in the of the storm ahead of a likely recession, while American consumer expectations feel to their lowest level in the decade. TheNasdaq 100 (USNAS100.I) and S&P 500 (US500.I) sharply stepped back on Tuesday; after company downgrades came in, while inflation woes increased after Oil rose for the 3rd day. US crude inventories fell 3.8 million barrels last week, while natural gas futures broke their downtrend and headed up. This supported oil stocks moving to fresh high ground again with Occidental Petroleum (OXY) rising or the fourth day and flagging bullish technical indicators on the week and monthly charts which means its shares could head higher still. As for company news; Goldman is expected to announce losses jumping over $1.2 billion in its consumer business and it may be forced to take on more lending-loss provisions. Shares in Nike, the world’s biggest sportswear companyfell 7% after investors digested its weak outlook, with gross margins (profits) tipped to flatten or even decline 0.5%.
APAC equities were mostly on the back foot as recession concerns took over with the US consumer confidence sliding below expectations. Consumer stocks took a big hit, but continued tightening also weighed on the tech sector. Japan’s Nikkei (NI225.I) was down over 1% despite a surge a utilities amid the continued stress on Japan’s electricity grid due to the current heatwave. Meanwhile, Australia’s ASX200 is down for the first day in five days, falling 1.1% today. As groundhog day goes, tech and high growth names are being sold. Singapore’s STI (ES3) was the sole green on the Asia board as US futures were in gains as well.
In China, CSI300 (000300.I) retraced and was down 0.8% after rising to a new high (since early March) above 4500 briefly. Hang Seng Index (HSI.I) and Hang Seng TECH Index (HSTECH.I) declined 1.6% and 2.9% respectively. Travel agent, airline, catering and casino stocks which registered high single-digit to double digit gains yesterday following China’s announcement to shorten its mandatory quarantine period to 10 days (down from 21 days) for inbound travellers, gave back some of those gains this morning. Auto makers were sold amid profit-taking as well as a negative report alleging accounting irregularities of NIO (NIO.US/NIO.SP/9866). NIO’s shares were 7.7% lower in Hong Kong’s morning session. Other auto makers were also down 3% to 8%.
ECB President Lagarde reiterated ECB's current stance on the continuation of its policy normalization path & will go as far as necessary to bring Euro Area inflation back to the 2% target in her speech at the ECB Forum on Central Banking yesterday. She hinted again at a 25bps rate hike in June and gave no proper insight into the anti-fragmentation tool. EURUSD sold off from 1.06+ levels to lows of 1.0504 and traded close to 1.0520 in Asia.
USDJPY is back above 136 amid gains in the USD on month-end flows. BOJ Governor Kuroda was on the wires too, saying that almost all of the inflation spike currently is due to the energy prices and hinting again that he doesn’t see wage pressures. He said that the 15-year deflation period in Japan has made firms very cautious in raising prices and wages. June Tokyo CPI is due on Friday and will eb watched closely as pressure remains on the upside. If inflation rises above 2.5%, the pressure on Kuroda to alter/withdraw the yield curve control policy will strengthen.
Crude oil prices dropped in the Asian session after a recent run higher as focus shifted back to supply side issues from Libya and Estonia, while Gulf oil producers are near max outputs. With no EIA data released last week due to a "systems issue", focus was on the API inventory data which suggested that crude stocks unexpectedly fell last week, almost erasing the major build from the week before. Gasoline stocks rose for the second straight week. With China’s restrictions also easing, it suggests a further run higher in energy may be coming.
US Conference Board Consumer Confidence Index continued to deteriorate, and fell to 98.7 in June from May’s 103.2, below expectations and reaching its lowest level since February 2021. While indicating that stagflation risks continue to run high, it is probably a signal to the Fed given that this survey particularly focuses on the labor market. The Expectations Index (consumers' short-term outlook for income, business & labour market conditions dropped significantly to 66.4 (Jun) from 73.7 (May), its lowest level since March 2013.
A number of Fed speakers were on the wires yesterday. Williams hinted at a debate for the July meeting between a rate hike of 50bps or 75bps. He expects GDP growth of between 1.0-1.5% this year, beneath the FOMC’s median projection of 1.7%, and said that a recession was not his base case. Williams is a voter, but that also seems to be the base view from the =Fed for now. Fed’s Daly also said something similar, ruling out a possible recession but expecting the unemployment to rise slightly.
Geopolitical tensions continued to reign as G7 oil price cap proposal to cut off Russia’s revenues gained traction. G7 has agreed to explore a ban on transporting Russian oil that has been sold above a certain price and the cap may extend to Russia's gas exports as well. There is a risk such measures could backfire as Russia could reduce energy exports in retaliation which in turn could led to a upward spiral in prices.
The National Development and Reform Commission reiterated China’s commitment to enhance both traditional as well as new infrastructure construction. Local governments have issued over RMB 2.54 trillion special bonds to finance infrastructure construction this year through June 16, tripling the among from the same period last year. The central government has instructed local government to use up this year’s RMB3.65 trillion special bond issuance quoter by the end of June and urge them to spend the fund raised by the end of August.
We think the market is set up for disappointment given strategist surveyed by Bloomberg are the most bullish they’ve been on quarterly earnings in 20 years. This means when companies provide earnings downgrades and report weaker than expected results, the market will likely to spooked and head lower. Companies in risk we think are in banking, property REITs, consumer spending, the industrial commodity sector and industrials (airlines and travel). Why? They will likely downgrade forward earnings for several reasons; firstly companies will likely be forced to factor in a slowdown in forward earnings; factoring in a likely recession (a drop in consumer and business spending), plus all government stimulus has dried up. Secondly, what’s happening under the surface is that US flight bookings have started to trend lower since May, plus high-to low US income households also began to slow down credit card spending, particularly over the last 4-6 weeks (according to Barclays). Plus, inflation has started to bite the US consumer with an increasing portion of the population living pay check to pay check (64%), while almost 50% of those earning six figures live pay check to pay check. All in all, rates rise will hurt consumers, and investors which is a why we think a larger pull back. Bloomberg Economics probability model also projects a 72% chance of recession before 2024. And if that occurs, history tells us, the market may fall 49-56% as it historically does.
Our Commodity Strategist Ole Hansen has flagged the recent move in Copper-Gold ratio as an interesting one to watch for being a recession indicator. It has reversed sharply lower in the last few weeks, suggesting US 10yr yields may need to come down.
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