Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equities rose while Treasuries and dollar fell despite the dismal US Fed manufacturing survey and continued jitters from debt ceiling. 2-year Treasury yields rose back to 4% while 10-year was back at 3.5% as Fed speakers Kashkari and Bostic attempted to push rate cuts out of 2023 Fed pricing. Crude oil saw a recovery as US hints at SPR refill, and China activity data on the radar today before focus turns to US retail sales. Technicals are suggesting that Tesla is in a bear trend, and earnings from Baidu and Home Depot will be in focus.
Key equity indices traded in narrow ranges and finished near their highs. S&P500 edged up 0.3% and Nasdaq 100 gained 0.6%. Materials, financials, and information technology outperformed. The regional bank space stabilized somewhat. SPDR S&P Regional Banking ETF (KRE:arcx) bounced 3.1% and PacWest Bancorp (PACW:xnas) rallied 17.6%.
Newmont (NEM:xnys) gained 2.6% after the gold miner securing a deal to buy Australian rival Newcrest Mining (NCM:xasx).
Fedspeak pushed back the market’s rate cut expectations as Kashkari said he has not seen much softening in the labor market and Bostic said rate cuts will not come well into 2024. A large supply of around USD20 billion in corporate new issuance also weighed on the market. Yields on Treasuries ticked up across the curve with the long end under most pressure despite a large drop in the Empire manufacturing index. The 2-year yield rose 2bps to 4.01% and the 10-year yield closed 4bps higher at 3.50%. For the rest of the week, investors will focus on the development of the debt ceiling negotiation (see more below).
Hong Kong's benchmark Hang Seng Index made significant gains of 1.8% as a flurry of corporate earnings reports loomed. The internet space saw Tencent spearheading the surge, with a notable gain of 3.9%, followed closely by Meituan's (03690:xhkg) 3.4% and Kuaishou's (01024:xhkg) 3.1%. However, JD.COM (09618:xhkg) exhibited a reversal from its brief one-day rally last Friday, with a loss of 2.6%.
A strong rally in A-share insurance and bank names on mainland bourses gave a boost to Ping An Insurance (02318:xhkg) and China Life Insurance (02628:xhkg), as both saw impressive gains of nearly 4%. Hong Kong-listed Chinese state-owned enterprise banks experienced gains ranging from 1-2%. Brewers and lithium stocks also had a good day, with China Resources Beer (00291:xhkg) surging 4.6%, while Tsingtao Brewery (00168:xhkg) and Budweiser Brewing each added over 3%. Genfeng Lithium (01772:xhkg) advanced 6.6%, and Tianqi Lithium (09696:xhkg) soared 7.9% on the back of rising lithium carbonate prices in May.
Reports emerged that the Shanghai Stock Exchange intends to convene a meeting with banks, insurance companies, and brokerage firms to enhance the valuation of companies in the financial sector, resulting in a significant rally in A-share insurance and bank stocks. In addition to the financial sector, the rise in A-shares was aided by surges in defense and new energy stocks. The CSI300 Index gained 1.3%.
The dollar was a notch weaker on Monday despite the dismal Empire state manufacturing and debt ceiling drama. Gains were led by AUD and NZD, with AUDUSD rising back above 0.67 eyeing the RBA minutes and China activity data due to be reported. Drop in NZDUSD below 0.62 remained temporary but a break above 100DMA at 0.6278 is needed to reverse the downtrend. Japanese yen remains range-bound, and USDJPY traded just above 136 despite the debt ceiling risks. GBPUSD rose back above 1.2500 with EURGBP slipping to lows of 0.8677.
Crude oil prices gained on Monday with reports that the US will start soliciting bids for crude to fill its depleted strategic reserves. Deliveries into the stockpile are planned for August, with awards to be announced in June, the Energy Department said. Meanwhile, supply disruption concerns rose with the wildfires in Canada continuing to rise in its main producing region increases. WTI prices rose above $71/barrel while Brent was above $75.50. China’s activity data is due to be reported today and will likely to key to get insights into consumption and industrial demands.
The next leg of debt ceiling talks are scheduled today and despite Biden’s optimistic tone after the delay last Friday, House Speaker Kevin McCarthy was rather downbeat saying that "We are nowhere near reaching a conclusion," and calling staff-level meetings "not productive at all." Meanwhile, Janet Yellen reiterated her warning that the government could run out of cash by June 1. The US Treasury on Friday said there was USD 88bln in extraordinary measures to use under its 34.1trln debt limit; that figure is down from USD 110bln in the previous week. Washington Post reported over the weekend that markets are not expecting a US default, but some companies are preparing; by selling short-term Treasury bills and corporate bonds maturing around June 1st, when the government might run out of cash, and buying safer money market funds even though they pay a lower return, in order to cover payrolls. Also, JPM did a client survey on asset price responses in the event of a US technical default, which saw a strong consensus that the Dollar would depreciate relative to safe haven currencies.
China's central bank, the People's Bank of China, has decided to maintain the benchmark 1-year Medium-term Lending Facility Rate at 2.75% during yesterday's fixing. However, the central bank has infused liquidity into the system via the facility, amounting to RMB125 billion, which is RMB25 billion higher than the amount that matured.
The NY Fed's manufacturing survey saw a sharp fall in business activity for May, with the headline index collapsing to -31.8 from April's +10.8 and expected -3.75. This was the second lowest reading of the post-COVID cycle after January's -32.9, and underpinned by weakness in both new orders (-28.0 vs prior +25.1) and shipments (-16.4 vs prior +23.9). Meanwhile, prices remained firm, with prices paid edging up to 34.9 from 33.0 while prices received were at 23.6 from 23.7.
Several Fed speakers were on the wires yesterday, highlighting that it is still too early to celebrate victory over high inflation. Kashkari (voter), speaking at an industry event, said inflation is much too high, though starting to come down. However, the Fed has more work to do and warned we should not be fooled by a few months of good data. He added the labour market is not as frothy as nine months ago, but is still strong overall. However Goolsbee (voter) said we need to monitor more than normal data sets and need to be attuned to credit, warning a lot of the impact of rate hikes is still in the pipeline. Bostic, who is not a voter now, said he does not see inflation coming down quickly and the Fed will not be looking at cuts until "well into 2024", warning the Fed may have to go up on rates but we are currently where his dot is portrayed in the dot plots. While the probability of a rate hike in June has gone up slightly to 20%, market continued to price in 70bps of rate cuts for 2023.
Tuesday’s retail sales print will be a test of the strength of the US consumer, while industrial production will be on watch to see if it confirms the uptick seen in PMIs. Headline retail sales are seen rising 0.8% M/M in April, offsetting some of the 0.6% M/M decline in March, core (ex-auto and gas) retail sales are seen up 0.2% M/M (prev. -0.3%), while the Control Group is expected to be up by 0.3% M/M, after -0.3% in March. The upside surprise in the retail sales print will however have to be substantial to make any impact on the market pricing of interest rate cuts by the Fed later this year, as banking sector and debt ceiling overhangs remain.
On Monday, the People's Bank of China (PBOC) released its Q1 Monetary Policy, which highlights that the banking industry is awash with liquidity, and interest rates remain at historic lows. In the report, the central bank noted that the recent drop in the consumer price index should not be overemphasized. Furthermore, the PBOC restated its position that housing is intended for residency and not speculation. The report underscores the critical role of preserving the stability of the financial system and the remenbi in monetary policy decision-making.
The key focus in U.S. earnings today is on Home Depot (HD:xnys) porting FY24 Q1 results (ending 30 April) before the US market opens with analysts expecting revenue growth of -2% y/y and EBITDA of $6.2bn down from $6.7bn a year ago as the home improvement retailer is facing cost headwinds from wages and a demand slowdown due to higher interest rates making home improvements based on loans more expensive.
Tesla seems to be failing in closing the bearish gap created after disappointing earnings in April. Our Technical Analyst Kim Cramer says Tesla needs to close above 179.10, but Monday’s close was again lower at 166.35. Medium-term Tesla is in a down trend on the weekly chart. Not even being able to test upper falling trend line and RSI is negative suggesting Tesla is likely to trade lower in coming weeks and months. Meanwhile, prices for Tesla’s key input, Lithium Carbonate, seem to be rebounding and if rebounding further it will hurt Tesla earnings which have announced a series of price cuts across its models.
According to the data released from the U.S. Treasury, China held USD869.3 billion in Treasury securities, as of the end of March, a USD20.5 billion increase from February. It was the first time of increase since July last year. China remains the second largest foreign holder in U.S. Treasury securities, behind Japan. Japan’s Treasury holdings ticked up to USD1,087 billion in March from USD1,082 billion in February.
Alibaba (09988:xhkg) announced a bold new strategy in response to the competitive challenges posed by the expansion of short-video and livestreaming platforms into the e-commerce space. The e-commerce giant pledged to invest heavily in artificial intelligence (AI) to enhance content creation and attract more users to its Taobao shopping platform. This move is seen as a critical step for Alibaba to maintain its edge in the fiercely competitive e-commerce landscape
Baidu (09888:xhkg) is set to report a 3.5% YoY decline in revenues, but a 2.2% YoY increase in non-GAAP net income in Q1. Despite pressure to invest in more computing power to support its AI initiatives, Baidu is expected to expand its operating margin modestly. Eyes will be on the management’s update on the search engine’s AI initiatives.
China is set to unveil its April activity data encompassing industrial production, retail sales, and fixed asset investment on Tuesday. According to a Bloomberg survey, industrial production is projected to grow by 10.8% Y/Y in April, above the 3.9% Y/Y in March. Retail sales are expected to increase by 22.0% Y/Y in April, much higher than the 10.6% Y/Y in March. However, the increases in the year-on-year rate of changes were due to the low base in April last year when Shanghai and other cities in China were under lockdown. On a sequential basis, April industrial production and retail sales are expected to have decelerated from March. Fixed asset investment is expected to rise by 5.7% year-to-date in April versus 5.1% year-to-date in March. Property investment is expected to dip year-to-date by 5.7% from last year.
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