APAC Research
Summary: Risk-on sentiment prevailed initially at Asia open on Monday, with news of a Credit Suisse takeover by UBS and additional dollar liquidity from the Fed. However, concerns linger in the credit markets, particularly with Credit Suisse's wiping out Additional Tier-1 bonds. The potential derating and repricing of bank and corporate credits and contagion risks to the financial sector complicate the decision of the Fed when it meets this week. Meanwhile, investors are eyeing Q4 earnings from Tencent, Meituan, and PDD for insights on China's economic recovery and consumption trend and Nike's quarterly results on global consumption.
Risk on returned to markets at the Asia open on Monday, with reports of a takeover of Credit Suisse by UBS and improvements to dollar funding liquidity. But while authorities have stepped in to prevent a systemic event, the fixes appear to be a short-term cure. We continue to watch the credit markets in the week ahead for any signs of further stress, specifically from the Credit Suisse AT1 bonds have been written off. This may pose a legal challenge given that equity value in Credit Suisse was made good, but it also means that values of AT1 bonds of other banks could take a hit.
Additional Tier1 (AT1) bonds, part of the Contingent Convertibles or ‘Cocos’ family, are hybrid bonds or callable securities which offer higher yields than more senior debt and can be converted from bonds into equity (or written down entirely) in the case of a credit event.
The fact that CS’ Cocos were not converted to equity but written down could mean a broader re-rating and repricing in the corporate bond markets. Also, on watch this week will be the credit default swaps for key US and European banks, any changes to their credit ratings and the financial conditions that are once again approaching to be the tightest in the cycle.
US CPI continued to be hot, coming in bang in-line with expectations except for the core MoM print which was hotter-than-expected. The disinflation narrative in goods inflation got only a modest support, with core goods prices remaining flat vs. +0.1% MoM previously. Services inflation continued to be sticky, and Powell's preferred "Supercore" metric (which excludes shelter and rent) rose to 0.5% from 0.36%, the highest since September.
However, the risks of a banking crisis have complicated the path of monetary policy, and the market is not even fully pricing in a 25bps rate hike for this week’s meeting. But looking at the response of the authorities to the financial risks, there is reason to believe that they have maintained the room to continue their fight against inflation. A pause or a cut at the March meeting, despite market remaining orderly from here, would spell panic for investors who would sense this as the Fed potentially still being cautious of systemic risks. Inflation print isn’t spelling relief yet, and the Fed will need to maintain its inflation-fighting credibility provided there is no further market stress until Wednesday’s announcement. Read our full preview here.
The Chinese Foreign Ministry has confirmed in a statement on its website that President Xi Jinping's much anticipated state visit to Russia will be held from March 20-22, marking the first such in-person visit with President Putin since the Ukraine war started in February 2022. It is being reported that the two leaders will discuss strategic cooperation, where as the world will be watching if President Xi makes an effort to mediate on the invasion of Ukraine. Meanwhile, the International Criminal Court (ICC) issued an arrest warrant for Russian President Putin, alleging forcible deportation of Ukrainian children is a war crime. The reaction to this accusation remains on watch and could create another geopolitical stir.
UK’s February CPI is scheduled for release on Wednesday, and another strong print is expected on the back of sustained price pressure from the service side of the economy, even if goods inflation starts to turn down. Bloomberg consensus expects February inflation to come in at 9.9% YoY from 10.1% YoY previously.
The Bank of England decision is due on Thursday, and the CPI report as well as Fed decision from a day before will be key inputs, but focus will still be on how the banking sector risks pan out. A 25bps rate hike is still on the table if no further fallout occurs, given the resilience of the UK economy and the tight labor market, but BOE is likely closer to a pause and may signal one in light of the financial stability concerns.
February inflation print is due in Japan on Friday and a softening is potentially in the cards after Tokyo CPI eased to 3.4% YoY in February from 4.4% previously. However, the core-core measure of Tokyo CPI was still firm at 3.2% YoY in February, suggesting the broader core inflation could remain firm as well this week. The trends reflect lower utility bills after PM Kishida announced a new subsidy package. As we move towards the middle of the year, base effects also continue to become a more prominent factor in inflation slowdown, which together with lower global yields in the wake of the recent banking turmoil could continue to take the pressure off for incoming BOJ governor Ueda to exit the yield curve control policy.
Also worth noting that the wage negotiations in Japan have concluded with the biggest wage hike in 30 years of 3.8%. BOJ Governor Kuroda had said that they need to see wages up by 3% to maintain inflation at 2%, so this means we can expect sustainable inflation pressures. While the pressure to tighten policy has eased, we still believe that if incoming Governor Ueda was to alter or cease Yield curve control, it has to come from inflation pressures and not market pressures. So this wage report is further ground for that, and yen strength could continue to build on safe haven flows and expectation of monetary policy tweaks.
Nike’s (NKE) shares have run up about 18% ahead of the retail giant announcing quarterly results on Tuesday, which are expected to be buoyed by strength across all regions, excluding China. Revenue is expected to rise about a 6% to $11.48 billion with a focus to be on inventory levels. Nike has increased EPS estimates in 8 consecutive quarters, and only missed revenue expectations twice in that span. We think Nike’s sales outlook will be upgraded in 2023, as its most profitable region, China, has reopened. Staying on its outlook, it’s hoped excess inventory will reduce quicker than expected with Chinese demand increasing – and this this would help the sportswear giant pare back on promotional discounts, and that will ultimately aid in profitability. Investors will look for commentary on how it's going to accelerate consumer growth, after making key hires.
General Mills (GIS) shares have fallen 5% this year, after the Wheat price lost 12%, which is somewhat a reflection of its hedging. The company recently raised its full-year earnings and organic sales forecasts, with organic sales growth for Q3 projected to rise to 11% from 4% in the prior year. Its pet food business is expected to return to positive net sales growth. And its launch of a fresh pet-food line with Walmart will likely bolster the pet segment’s outlook. Broadly, its guidance will be closely watched as its commodity hedging has been helping the business outperform competitors that don’t. Its profit outlook will depend on whether prices can rise more than inflation. If the war between Russia and Ukraine continues, inflation of food staples will too and this might push another round of price hikes, following the hikes made in January.
Investors are closely watching Tencent (00700:xhkg), Meituan (03690:xhkg), and PDD (PDD:xnas) as they prepare to release their Q4 earnings this week, with a focus on China's consumption trend, the strength of the country's economic recovery, and Q1 business outlook.
PDD, reporting on March 20, is expected to see 53% Y/Y revenue growth due to increased merchant activity, with its adjusted net profit forecasted to rise 46% Y/Y.
Tencent, which reports on March 22, is expected to see modest total revenue growth and a 24% Y/Y increase in adjusted net income, with growth in its gaming and advertising businesses offsetting slower growth in fintech and cloud.
Meituan, reporting on March 24, is forecasted to see strong demand in its food delivery business despite Covid disruptions, but weaker demand in its in-store, hotel, and travel segments. The company's adj. EBIT loss is expected to narrow.
Overall, these earnings reports will provide key insights into the state of the Chinese economy and the China reopening trade.
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