Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: US equity markets turned tail badly and sold off yesterday, with the mega-cap heavy Nasdaq 100 losses on the day far greater than for the broader market. The likely source of concern is a further spike in US treasury yields, with the 10-year Treasury yield benchmark within a couple of basis points of the late 2021 highs before easing back. The next test for US yields arrives today with the FOMC minutes and then the US payrolls and earnings data for December up on Friday.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - yesterday’s US session was painted in red across growth/technology stocks with our NextGen Medicine, Bubble Stocks, and E-commerce baskets leading the declines down around 4%. US 10-year yield has increased 14 basis points this year, and while a sizeable move relative to recent moves, but it cannot explain the move in technology stocks. Our guess is that investors continue to rotate and are increasing their exposure towards stocks with positive inflation sensitivity like financials, energy and mining. Nasdaq 100 futures are trading around the 16,200 level in early European trading hours which is just above the 50-day moving average and if the index breaks below, we could see a quick follow-through to 16,000.
USDJPY – the USDJPY pair burst higher yesterday as it continued to absorb the steep rise in US long-term US Treasury yields, which were suddenly having a look close to late 2021 highs at one point yesterday after a quiet rangebound close to the 2021 calendar year. A high of 116.35 was posted yesterday before some consolidation set in, as risk aversion may have brought some support to the US treasury market. USDJPY is traditionally very sensitive to US long-term yields and the over-riding question for coming days is whether the spike in yields is a one-off “calendar roll” effect or something that will sustain and potentially drive USDJPY much higher still. Next test for yields and USDJPY besides today’s FOMC minutes is how the market absorbs the Friday US payrolls and earnings numbers.
Crude oil trades near the highest since late November after the OPEC+ group agreed to continue their steady pace of monthly production increases while the API report showed a large decline in US crude inventories. With the demand threat from the omicron virus variant easing, the group lowered its projected surplus for the first quarter, with China’s approach to handling outbreaks the potential biggest source of short-term demand concern. With several members including Nigeria, Angola and Russia struggling to reach their quotas, the actual increase, just like previous months could end up being half the agreed 400,000 barrels a day. Above $80, Brent may take aim at $83 with support at $78.50.
Gold (XAUUSD) has managed to shrug off the negative impact of rising real yields to trade near the middle of its current $1800 to $1833 range. Partly supported by a weaker dollar after softer US ISM Manufacturing and Prices Paid (see below) left the market wondering whether the FOMC will or needs to deliver the three rate hikes priced in for 2022. In addition, the weakness seen across the more speculative part of the stock market and geopolitical tensions on Europe’s eastern borders may also lend a hand. Focus turning to today’s FOMC minutes and Friday’s job report.
US 10-year Treasuries and German Bunds - watching yields at the longer end of the curve carefully here as both the major US longer-term treasury yield benchmark and German bunds are nearing late 2021 highs, with the former in focus as the 1.70-75% yield area comes into play, and for bunds, as the 2021 yield high posted in October at –6.5 basis points comes into view (yesterday closed at –12 basis points). Long yields are both a reflection of the growth outlook, whether inflation is seen as likely to be sustained, and are an important input in asset valuation, particularly highly valued growth stocks.
What is going on?
US Dec. ISM Manufacturing in at 58.7 vs. 60.0 expected and 61.1 in Nov. While covid impacts were still emphasized, including worker absenteeism and shortages of materials, sharp declines in delivery times and easing price pressures were noted as the Prices Paid index fell to 68.2 from 82.4, the lowest reading since November of 2020, though still pointing to rising prices, if at a slower pace. The employment sub-index rose to 54.2 from 53.3, an eight-month high.
Ford Motor Company shares rise to 20-year high on doubling of F-150 Lightning production capacity. This is a sign that demand for the EV version of its long best-selling F-150 pickup will be strong as it will begin to take orders for the truck starting tomorrow, with deliveries set to begin in the spring. The company has booked more than 200,000 non-binding orders for the F-150 Lightning, but do not expect more than 150,000 deliveries next year and only 600,000 EVs by 2024, which should be compared to Tesla’s 1.5-1.6mn this year.
Italian presidential election date set to begin January 24 - yesterday, Italy’s parliament established that date in which over a thousand senators and other officials will start the process of electing a new president for a 7-year term via secret ballot. It is a process that could take several days. With current PM Mario Draghi seen as a top candidate for the position, this could mean eventual snap elections, with an electorate seen as rather more right populist and more EU-skeptic than the current caretaker government led by Draghi.
National Bank of Poland hikes policy rate 50 basis points as most expected, taking the policy rate to 2.25%. Last week the bank guided for further rate hikes to come while predicting that CPI inflation measures would peak in June above 8% (November year-on-year inflation was 7.8%). A press conference is set for today. EURPLN dropped to new lows since last October, trading 4.655 this morning and thus breaking below its 200-day moving average.
Hang Seng Tech Index declines 4.3% extending global tech selloff. The selloff in e-commerce, biotechnology, and bubble stocks that started yesterday during the US session extended into the Asia session taking the Hang Seng Tech Index down to levels not seen since May 2020 and on par with levels in late 2017 making it more difficult for global investors to love Chinese and emerging market equities. Hopefully, the Chinese government will soon start more broad-based stimulus which could turn the tide in Chinese equities.
The Bloomberg Grains index has started the year on a firm footing, risen 2.2% during the first two days of trading. Led by soybeans (SOYBEANSMAR22) which has rising to a six-month high on fears over the South American harvest, where hot and dry weather conditions in Brazil and Argentina may reduce an up until recently expected bumper crop. The U.S. Department of Agriculture is due to release world supply and demand estimates on January 12 in its first major report of the year while the UN FAO will publish its world food price index for December on Thursday.
What are we watching next?
FOMC Minutes and US Dec. ADP Employment Change data up later today. First up later is the December ADP private payrolls number, which is expected to show an increase of more than 400k jobs after three months of over 500k growth per month. The omicron covid surge will likely affect many services job growth in particular in January and possibly February as indicators like OpenTable restaurant booking show a sharp reduction in restaurant visits over the last two weeks, but the markets seem willing to look through omicron impacts for now. Later, the FOMC minutes will be released and analyzed for any signs of dissent in either direction or urgency on lifting rates or even eventually shrinking the Fed’s balance sheet as the Fed has declared that fighting inflation is now its chief focus. The market is leaning for the first-rate hike to arrive at the March FOMC meeting.
The annual rebalancing of the world’s two biggest commodity indexes, the energy heavy S&P GSCI and the broader Bloomberg Commodities Index (BCOM) will start on Friday, and over a five-day period the indexes, followed by billions in assets will reset their positions based on how the individual commodities performed in 2021, production levels and overall trading volumes. The biggest market impact should come from last year's biggest winners and losers as their positions will be adjusted back to their weightings. A big winner like crude oil could according to estimates see up towards $4 billion worth of selling. Overall, the S&P GSCI has said its largest sector percentage increase will be agriculture, led by weight increases in corn and soybeans while previous metals will see the largest percentage weight decrease. Still, the general market impact should be limited with the changes being well flagged in advance.
Earnings Watch – Teledyne and Jefferies did not report earnings yesterday as indicated in the earnings calendar. Teledyne based on previous Q4 earnings will likely report late January or early February, and Jefferies has updated its report date to 12 January (next Wednesday).
Wednesday: RPM International
Thursday: Walgreens Boots Alliance, Conagra Brands, Constellation Brands
Economic calendar highlights for today (times GMT)
0815-0900 Euro Zone Final Dec. Services PMI
1315 – US Dec. ADP Employment Change
1330 – Canada Nov. Building Permits
1530 – EIA's Weekly Crude and Product Stock Report
1900 – US FOMC Meeting Minutes
0145 – China Dec. Caixin Services PMI
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