Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Equity market futures in Europe and the USA trades higher with Asian stocks, supported a rally in US Treasuries driven by safe haven demand on Middle East tensions and after FOMC members suggested that the recent surge in long-end rates may mean less need for further tightening. The dollar traded in a narrow range overnight while gold pushed higher supported by Middle East tensions and rates focus while Brent crude holds below $89 resistance. Looking ahead, the Middle East focus remains a key focus ahead of US inflation data due Thursday.
The Saxo Quick Take is a short, distilled opinion on financial markets with references to key news and events.
Equities: Yesterday’s rising geopolitical risks in the Middle East showed how investors react during periods of stress. The defensive sectors (energy, utilities, health care, and consumer staples) were best performing sectors and defence stocks also reacted positively to the recent events with especially European defence stocks rising. Today’s key event in US equity markets is earnings from PepsiCo (bef-mkt) with investors curious of whether PepsiCo will confirm Walmart’s comments on Friday that the new obesity drugs are already negatively impacting demand for soft drinks and snacks.
FX: The safety bid for the dollar remained short-lived, with Fed speakers starting to turn less hawkish as they consider the financial tightening because of the higher bond yields. Generally, the greenback traded in tight ranges overnight but so far, no major reversals have materialised to suggest the rally is over. Focus on risk sensitive currencies like EURCHF, NZD and AUD and not least USDJPY which briefly slid below 148.50 before turning higher. In EURUSD watch the 21-day moving average, currently at €1.06, which has more or less dicated the downtrend since August.
Commodities: Crude oil prices have steadied with Brent trading below $89 resistance but is likely to remain supported for now amid the risk of fresh instability in the Middle East after the US warned Iran not to get involved. European natural gas prices jumped 15% on Monday after Israel ordered Chevron to temporarily shut an offshore gas platform because of safety concerns and on worries about the Suez Canal, a major shipping route for LNG to Europe. Gold meanwhile continues to attract short covering and fresh demand amid Middle East tensions and Fed members hinting a rate pause.
Fixed income: Sovereign yield curves bull-flatten as the Israel-Hamas war increases safe-haven demand. Although it’s too early to understand the market extent of such conflict, it’s important to note that the events are unfolding on the back of weak bond sentiment. An intensifying of the conflict will deepen stagflation on both sides of the Atlantic, as growth further decelerates, while inflation increases. Also, as governments prepare for war, they will need to issue more bonds support their spending. We, therefore, expect the drop in yield to encounter strong support. This week the US Treasury is going to sell 2-, 10- and 30-year notes while the FOMC minutes and CPI numbers are released. We remain neutral on duration and risk, as we determine the extent of news coming from Israel.
Volatility: The Israel-Hamas war initially pushed the VIX towards 19.60. As the market turned around, the VIX dropped back below 18 to end at 17.70. Less hawkish comments by Fed-speakers and a drop in the 10Y Yields gave an uplift to the market. With the bonds at multiyear lows, the 20+ Year Treasury Bond Ishares ETF (TLT) has experienced a peak in implied volatility last week but is clearly recovering as the market shows that the Put/Call ratio went from 1.2 (more puts than calls) to 0.33 (more calls than puts).
Macro: Dallas Fed President Logan (voter) – usually a hawk – said that higher long-term rates mean less need for rate hikes. Fed vice-Chair Jefferson said that the Fed is “in a position to proceed carefully in assessing the extent of any additional policy firming that may be necessary”. He said he will remain cognizant of the tightening in financial conditions through higher bond yields and will keep that in mind when assessing the future path of policy.
In the news: Europe has recently announced a probe into Chinese EV production and now it has announced a probe into Chinese steelmakers (FT). Collaboration by a Saudi Arabia university with Chinese universities on AI could cause US AI chip export controls against Saudi Arabia (FT). Chinese real estate developer Country Garden warns that it may fail on its offshore obligations (Reuters).
Macro events: IMF World Economic Outlook; US NFIB survey (Sep) exp 91.0 vs. 91.3 prior. Fed’s Perli, Bostic, Waller, Kashkari, and ECB’s Villeroy speak.
Earnings events: PepsiCo reports FY23 Q3 earnings (ending 30 September) today at 10:30 GMT with analysts expecting revenue growth of 7% y/y and EPS of $2.16 down 1% y/y.
For all macro, earnings, and dividend events check Saxo’s calendar.