Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: Equity markets suffered one of their worst weeks since the lows of 2020 last week, with the US Nasdaq 100 having entered official correction territory with a drawdown of well over 10 percent. This comes ahead of a pivotal FOMC this Wednesday, as most believe the Powell Fed is set to indicate that it will hike rates in a determined fashion beginning at the March FOMC meeting. The rise in US yields was tamed last week, perhaps as the market feels that the Fed will not want to surprise to the hawkish side once again, now that market nerves are so rattled. In Asia overnight, the week has started with a rebound in US equity futures with treasury yields, the dollar and crude oil also climbing.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures rebounded in Asian trading while Asian stocks came off session lows. The sentiment, however, remains fragile ahead of Wednesday’s FOMC meeting and following the worst stretch for global shares last week since the pandemic began. Aside from the Fed, earnings update this week from Microsoft, Apple and Tesla will also help shape sentiment.
Hang Seng (HK50.I) Hang Seng Index pulled back slightly mid-day with weakness in technologies, automobiles and pharmaceuticals. Up 6.3% YTD, it has outperformed the U.S. and the A-share market amid Chinese policies aiming at stabilizing the economy. Sentiments in the A-share market have, however, been lackluster this year. When expectations of more stabilization policies having taken hold, Chinese stocks in infrastructures, home appliances, properties, brokerage, food and agriculture are likely to pick up in momentum. Today the PBOC injected 14-day liquidity over the Chinese New Year holiday at 2.25%, being 10 bps lower from December and in-line with last week’s cuts in policy rates.
Bitcoin (BITCOIN_XBTE:xome) and Ethereum (ETHEREUM_XBTE:xome) - A hefty sell-off occurred on Friday and Saturday in the crypto space, following Thursday’s proposal of a crypto ban by the Russian central bank. The crypto market appeared to stabilize on Sundays, and this morning Bitcoin is trading around USD 35,300 and Ethereum around USD 2,420, both down close to 50% from their November record peaks.
USDJPY and JPY crosses - the combination of cratering risk appetite last week with safe-haven sovereign bonds catching a bid and yields falling has seen a sharp recovery in the Japanese yen, taking USDJPY withing striking distance of the 113.50 pivot low from mid-month, a break of which could open up for the 112.50 area lows of last October. The major pivot lows are also coming back into view in other major JPY crosses, like EURJPY, where the prior break below 128.00 failed to stick. Lower long US yields after the FOMC meeting this Wednesday would likely be needed to support further JPY strength.
Crude oil (OILUSMAR22 & OILUKMAR22) traded higher in Asia overnight following a very shallow correction towards the end of last week. Supported by tight market conditions, Brent may attempt another push to the upside towards key technical and psychological resistance at $90 a barrel. Also supporting the market this Monday are reports of another attempted missile attack on the UAE and optimism that omicron variant cases in the US may soon peak. Speculators continue their rapid accumulation of crude oil exposure last week when the combined net long in Brent and WTI reached a ten-week high at 559 million barrels, and during the past four weeks they added length at the fastest pace since January 2020.
Gold (XAUUSD) holds above support at $1830 despite the overnight recovery in risk appetite as seen through the bounce in US equity futures, firmer treasury yields and the dollar. Offsetting these headwinds are the latest plunge in cryptocurrencies as well as geopolitical concerns in Europe. The market will turn its attention to Wednesday’s FOMC where it will look for guidance on the timing and the pace of future rate hikes as well as initiatives that may shrink the Fed’s balance sheet. Speculators sold gold ahead of last week’s breakout while the world’s biggest gold ETF (GLD:arcx) recorded its biggest net inflow on Friday since listing in 2004, thereby supporting the biggest weekly jump in total holdings in 18 months. Resistance at $1850 followed by the November peak at $1877.
US Treasuries (IEF, TLT). This week's focus will be on Wednesday’s FOMC meeting, where the market expects Powell to clarify how he will fight inflationary pressures. Currently, four interest rate hikes are priced for this year, starting in March. A big focus will be whether the Fed is looking to combine rate hikes with balance sheet policies to tighten the economy more efficiently. If that were the case, long-term yields would likely resume their rise. Yet, it’s key to bear in mind that geopolitical tensions and the prospects of a slowdown in growth could keep the long part of the yield curve compressed, making it difficult for 10-year yields to approach the 2% pivotal level.
Italian BTPS (BTP10). The Italian parliament convenes today to vote for a new president of the Republic (see below). This vote could trigger intense volatility in Italian sovereign bonds as Mario Draghi is one of the names proposed for the presidency. If Draghi leaves his job as Prime Minister, the country will suffer a political vacuum that could lead to early elections, and his departure could also jeopardize the reception of the funds under the NextgenerationEU fund. Investors should be prepared for a period of intense volatility that could see the BTP-Bund spread rising to 160bps.
What is going on?
December Canada retail sales fell by 2.1%. This is a flash estimate based on responses from 50.6% of companies surveyed. The drop is likely to be higher in the final estimate due to the impact of the Omicron variant and many challenges facing retailers (especially the risk of shortage). Expect the situation to remain gloomy in January, notably for bricks-and-mortar retailers.
December UK retail sales sank 3.7% from the month before. Clothing and other non-food sales dropped by 7.1%. This negative print was largely expected after strong pre-Christmas trading in November and due to the introduction of new restrictions in England.
Iron ore price futures (SCOF2) in Singapore rose 2.4% on Friday to $137.06 supported by China’s second interest rate cut. We haven’t seen iron ore sentiment this high since September last year. We except the iron ore price to rally after China’s central bank injected 150 billion Chinese Yuan into the banking system today and cut the repo rate. However, the market could be dived as iron ore orders are likely to fall ahead of China kicking off the Beijing Winter Olympics and starting the Luna new year holiday. Post March, you could expect the iron rally to continue, supporting the recovery of BHP and Rio.
What are we watching next?
Wednesday’s FOMC meeting is going to be pivotal across assets. The market is pricing four interest rate hikes in 2022 with one coming into play already in March. It will be key to understanding whether the Fed is going to match market expectations or if it is leaning towards implementing rate hikes with balance sheet policies to tighten the economy. That could have an impact on the shape of the yield curve as well as the market’s risk appetite.
The presidential Italian election is kicking off today - The process to elect the successor of the incumbent president Sergio Mattarella is starting. In recent weeks, current Prime Minister Draghi has been floated as the frontrunner. Other potential candidates are the current justice minister and former judge at the Constitutional Court Marta Cartabia and two former Prime Ministers (Romano Prodi and Paolo Gentiloni). Former Prime Minister Silvio Berlusconi was officially running. But he abandoned the bid on Saturday. History teaches us that most of these names mentioned in the lead-up to the vote are there to get burnt, except for Draghi. The race is therefore wide open and potentially full of surprise (see our full analysis here).
Portugal legislative elections on 30 January – In December 2021, President Marcelo Rebelo da Sousa called for snap elections after the incumbent Socialist government under Antonio Costa failed to get its 2022 budget proposals approved by the Parliament. Opinion polls suggest that the Socialist Party, who has been in power since 2015 with support from the far left, is likely to win the election. The far-right Chega (meaning ‘Enough’), which entered parliament in 2019, could perform quite well.
French presidential election update – The ‘Popular Primary’, a left primary organized by a group of civil society activists, will take place from 27 to 30 January. The aim is to pick a single official left candidate for the presidential election. Already 100,000 citizens have registered (for comparison, there were around 122,000 registered voters to the Green primary of September 2022). This primary will be a failure. All the lead candidates refuse to participate, except for the former Hollande minister, Christine Taubira. In our view, the Left will not play a major role in the 2022 presidential election, no matter what the outcome.
Earnings Watch
Economic calendar highlights for today (times GMT)