Jumbo rate hikes is the new norm, but brace for China’s upcoming rate cuts. Is inflation really near peaking?

Co-written by Market Strategists Jessica Amir in Australia, Redmond Wong in Hong Kong, Charu Chanana in Singapore.

What’s happening in markets?

Nasdaq 100 (USNAS100.I), S&P 500 (US500.I) and MSCI Asia Pacific ex Japan (FMASM2) – US equities were broadly positive overnight with the S&P up 1.12% mostly led by gains in travel related stocks as Delta earnings highlighted a robust outlook for summer bookings. American Airlines (AAL) led the gains, up over 10% with Delta (DAL) up over 6% despite reporting a quarterly loss. The tech-heavy NASDAQ was up 2.03%. Asian stocks caught a bid too at the open with MSCI Asia Pacific ex-Japan (FMASM2) in gains of over 1%. Nikkei (NI225.I) was supported by gains in Fast Retailing (9983) which is due to report results today. STI (ES3) was up 0.4% as central bank tightened monetary policy.

HK & China equities found support from anticipation of imminent easing. Hang Seng Index (HSI.I) and CSI300 (000300.I) opened higher modestly. Yesterday, in a State Council executive meeting chaired by Premier Li Keqiang, the Chinese Government pledged to “cut reserve requirement ratio (RRR) at the appropriate time” to support the economy. In the same meeting, the State Council encouraged household consumption on passenger cars and white goods. The shares of auto makers surged 4-7%. Hair Smart Home (06690), a leading white good producer, rose 3%.

The Australian share market (ASX200) rose 0.4% on Friday, managing to gain 0.6% this week. Today the market was led by the key themes that will likely do well this year; Broad commodities, Battery lithium stocks and economic reopening stocks. Ratings agency Moody’s affirmed Qantas (QAN) is well positioned to restore its credit profile over the next 12-18 months, as all domestic borders are now open and international borders are continuing to open. Secondly, China’s central bank (the PBOC) is expected to cut rates, again, so this is boosting commodities stocks. The Iron ore (SCOA) price rose 1.6% to $154.30 extending the steelmaking ingredient’s long term uptrend and pushing up BHP (BHP) shares up 1.3%, to back of over $52.42 for the second time since August. We also think BHP’s rebound will continue and it’s likely to move to higher levels.

Crude oil (OILUKJUN22 & OILUSMAY22) fell 0.6% to $103. We believe inflation will likely peak later this year, with commodity supply remaining short and demand to hit another high later this year as the Northern Hemisphere heads to winter. Meanwhile, after Musk previously said he would consider getting into lithium mining, a ‘fake’ rumour circled claiming Tesla (TSLA) bought Nevada-based lithium company Lithium Corp (LTUM). Both stocks jet packed higher and stoked more fire into most lithium stocks.

Singapore’s tighter monetary policy and reopening to support SGD. The Monetary Authority of Singapore (MAS) tightened policy settings in two steps - raising the slope and re-centering its policy band higher. In effect, this may be in line with RBNZ’s and BoC’s 50 basis points rate hikes this week. Singapore’s Q1 GDP growth was slower than expected at 3.4% y/y but inflation remains the key concern amid a surge in commodity prices, strong pent-up demand and a tight labor market. USDSGD was down nearly 0.5%, and scope for further tightening this year remains. This means SGD will continue to benefit from a hawkish central bank and the reopening theme that we have been talking about.

Bank of Canada (BOC) announced a 50-basis points rate hike. After RBNZ on Wednesday, the BOC also delivered a 50bps rate hike, raised its estimated neutral rate and started quantitative tightening. The higher neutral rate was the most intriguing development and introduces new upward risks to terminal rate forecasts. While CAD strengthened, it should be noted that it also gets support from oil prices. But yields have dropped both in the case of New Zealand and Canada. A wise man once said, when central banks start panicking, the markets stop panicking.

What to consider?

China’s State Council signals imminent cut in the Reserve Requirement Ratio (RRR). In its executive committee meeting yesterday, China’s State Council said that the RRR would be reduced timely to support the economy. Historically, after the 10 times that the State Council having called for RRR cuts, the People’s Bank of China (PBoC) delivered the cut withing 2 to 20 days. For the previous cut in December 2021, the lag was only 2 days. The market is now in high anticipation that the PBoC will announce a RRR cut by 50-basis points in the coming days.  In addition, the PBoC is likely to cut its 1-year Medium-term Lending Facility (MLF) rate by 10bps as soon as tomorrow. A cut in the MLF will lead to Chinese banks cutting their 1-year and 5-year Loan Prime Rate (LPR) on April 20 at their monthly fixing.

Asia central banks ex-Japan and China to turn increasingly hawkish as inflation pressures mount. Bank of Korea also hiked rates by another 25bps when the consensus was split between a no change and a hike. Most Asian central bankers are now getting worried about inflation, and we will see more and more policy action in the region in the weeks to come. India’s inflation was above the central bank’s target of 6% for a third consecutive month in March.

US producer price index rose 11.2%, suggesting strong underlying inflationary pressures. Th 11% handle is a massive jump and showed strong underlying inflation pressures at the factory gate, raising doubts that a decline in core inflation seen on Tuesday would be sustainable. It is clear that the U.S. Federal Reserve is behind the curve. Expect a 50-basis point interest rate hike at the May FOMC meeting.

Don’t believe consensus and the headlines, interest rates will get ugly high. So back the right stocks. The Fed’s very own model, to forecast interest rate, the Taylor rule, suggests interest rates should be 9%. Not where the market thinks they’ll be at end year (at 2.6%). So expects rates to be at least 6% next year. What does this mean for stocks? Companies, with strong balance sheets, scale, particularly in commodities, cybersecurity and defence (military related spending areas) and in even Mega Caps, will likely to do, regardless. The market is already telling us this, and it’s been favouring those stocks who will do well over the next 6-9 months. There is still good value, and bargains to be made in energy and materials stocks, especially ahead of buy backs in the likes of. Even if the war is Ukraine is over tomorrow, cash flows, and free-cashflows, in these companies is still aggressively rising, and that’s the key to share price growth in this new market of record inflation and rising rates.

Australia’s employment growth is strong. What’s next? Australia’s unemployment released today, showed the rate remained at 4% in March, its lowest in 13.5 years. The market was a little more optimific and thought unemployment will fall to 3.9% today but that didn’t happen. Employment only rose by about 18,000 in March, instead of the 40,000 due to covid19 restrictions and as China has not yet opened its borders yet, so the hospitality and tourism sector is not yet at full employment. We will likely see unemployment fall to 3.9% later this and 3.25% year. This supports Australian banks, the travel sector and the AUDUSD.

EURUSD has seen some recovery ahead of the ECB meeting today. EURUSD has moved above 1.0900. Still, the struggle for the euro continues. The ongoing unease as Russia looks set to widen its offensive in eastern Ukraine and concerns that the ECB will remain dovish today perhaps weighing. EURGBP is also steady at 0.8300. The ECB is unlikely to announce any changes to policy but may still maintain its hawkish guidance.

China encourages spending on white goods and reverses restriction on car purchases. In the same meeting mentioned above, China’s State Council pledged to boost household consumption on healthcare, caring of elderlies and infants, passenger cars and white goods. It further instruct local government not t put on new restriction on car purchases and increase the quotas gradually for the prevailing restriction already in place. 

 
Trading ideas to consider

Asia travel stocks in focus. Delta earning report has also spurred gains in Asian airline stocks. Japan Airlines (9201), ANA (9202), Qantas (QAN), Singapore Airlines (C6L) are all catching a bid. Reopening theme bodes well for Asia Pacific with improved vaccination rates and broadening steps to reopen border.

Hong Kong and mainland China A shares are likely to find near-term support from heightened expectation of imminent monetary easing and other policy initiatives to boost the economy. In medium-term, however, markets will continue to be pressured by the accelerating monetary tightening by the U.S. Fed and the drag to the Chinese economic growth incurred by the widespread Covid-related lockdowns.

Elon’s Twitter (TWTR) shareholding will remain a catalyst. Elon Musk may be increasing his stake to over 10% to force the needed change such as employee cuts and a likely shift in revenue model from ad-driven to premium/base user fee model similar to YouTube. The disclosure of Elon's ownership remains the next big catalyst to watch for the stock.

Earnings releases to watch:

• Thursday: China Northern Rare Earth Group (600111), Fast Retailing (9983), Ericsson (ERICB), UnitedHealth (UNH), Wells Fargo (WFC), Morgan Stanley (MS), Goldman Sachs (GS), Citigroup (C), US Bancorp (USB), PNC Financial Services (PNC), Coinbase (COIN), State Street (STT)
• Friday: Hangzhou Hikvision Digital (002415)

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