Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Somewhat muddled action across markets, as yields rebounded on hawkish ECB talk and strong US jobless claims data, halting the latest advance in the US dollar and Japanese yen. Equities traded on the weak side again, with Netflix reporting stronger than expected subscriber growth after hours, while its CEO is set to leave after twenty years in the position. Asian stocks advanced ahead of the week-long holiday for greater China to mark the Lunar New Year.
Next week is the Lunar New Year holiday, during which Shanghai and Shenzhen’s stock exchanges will be closed for the whole week next week and the Hong Kong bourse will be closed from Monday to Wednesday. Ahead of the long holiday, investors were better buyers on Friday to position for potentially a strong recovery in the Chinese economy in the Year of the Rabbit. Hang Seng Index advanced more than 1% and the CSI300 climbed around half a percent. Oil and gas, China internet, and educational services stocks led the charge higher in the Hong Kong bourse. CNOOC (00883:xhkg), surging 5.2%, was the top gainer within the Hang Seng Index, followed by Meituan (03690:xhkg), up 4.6%. In A-shares, non-ferrous metal, coal mining, rare earth, and educational services outperformed.
The ECB’s Klaas Knot (well known to lean hawkish) talking “multiple 50 basis point” hikes saw European yields righting themselves yesterday and helped put a floor under the euro yesterday as EURUSD has refused to drop below 1.0800, stuck in a very narrow range. Strong US jobless claims data helped US yields pop back higher above the key levels taken out on the weak Retail Sales release the prior day, but this did very little to revive the US dollar’s fortunes, as it slumped back against most currencies, save for the even weaker JPY, which didn’t appreciate the fresh jump in bond yields.
Crude oil prices are heading for a second weekly advance after recovering from a midweek wobble. Supported by continued China demand optimism and strength in the product market with gasoline and diesel both trading at a two-month high ahead of the embargo on Russian products from next month. Reports that China’s covid caseload has peaked further boosted optimism that demand will start to recover more sustainably following the Lunar New Year holiday. Global demand expectations got a boost as US jobless claims data supported the view that the labor market is still tight. In the US, an 81% jump in exports and the first week without injections from SPR nevertheless saw inventories jump 8.4m barrels as refinery demand struggled to recover following the late December cold blast and outages. Having bounced from support at the 50-day moving at $83.77 in Brent, a weekly close above $87 may signal further strength in the week ahead. In WTI that level is at $81.
Gold continues to show resilience and following a three-day pullback during which it found support at $1896 it jumped to an eight-month high overnight at $1835, supported by US yields and the dollar remaining near new cycle lows. As long these two key sources of inspiration for momentum and machine-driven strategies continue to support, gold is likely to remain supported. This despite a continued lack of interest from ETF investors as total holdings remains near a two-year low, having seen no pickup during the past two months rally.
Copper is heading for a fifth weekly gain with optimism about a pickup in demand as China reopens being supported by supply concerns. Protests in Peru are threatening supply from two mines accounting for nearly 2% of the world’s copper output, this at a time when visible inventories held at exchanges are low and demand is expected to rise as China recovers and the energy transition continues to gain traction.
Treasuries erased their gains in Asian hours as yields followed German bunds higher in London hours on pushbacks from ECB’s Lagarde and Knot to speculation on a downshift of ECB rate hikes from 50bps to 25bps. Yields on the short end climbed further following a smaller-than-expected 190K rise in initial jobless claims and an increase of the Philly Fed Business Outlook Index by 4.8 points to -8.9, better than the consensus estimate of -11.0. The 6-month ahead conditions sub-index improved nearly 6 points to 4.9. While Fed’s Vice Chair Brainard reiterated “the need for further rate increases, likely to just above 5 percent”, she suggested that it is possible that inflation can come down “without a significant loss of employment”. The USD17 billion TIPS auction went very strong with bid-to-cover at 2.79, well above the average of 2.25. As the federal government reached its debt limit, Treasury Secretary Yellen wrote a letter to Congress about measures that the Treasury Department is taking to keep meeting obligations until at least early June to allow time for Congress to work on raising the debt limit. Yields on the 2-year rose 4bps to 4.13% and those on the 10-year climbed 2bps to 3.39%, bringing the 2-10-year curve 2bps more inverted at -74.
ECB's Knot said that market developments of late are not entirely welcome and that the ECB won't stop after a single 50bps hike, planning to hike by 50bps multiple times. Despite a softer CPI print lately, Knot said that there are no signs of underlying inflation pressures abating and said that the ECB will be in "tightening mode" until at least mid-year. ECB President Lagarde was also on the wires, saying economic news has become much more positive as the contraction in Eurozone 2023 GDP may be smaller than previously expected, so the ECB will stay the course with rate hikes.
The jump of 7.1% came, however, after a worse than 3% slide in yesterday’s session. Netflix added 7.66 million subscribers versus estimates of +4.5 million, though the number is still down –7.5% year-on-year. Company guidance for Q1 was somewhat lower than expected for EPS and operating margin, but the full year guidance was above consensus estimates for free cash flow.
The US consumer products giant registered its first year-on-year quarterly decline in revenue in more than five years. Revenue dropped –0.9% as it noted some consumers are cutting back on purchases due to price hikes, and volume trends worsened by some 6% versus last year, half due to lower final sales, half due to inventory reductions. Earnings beat expectations slightly at $1.59 per share versus $1.66 last year. The stock was down some 2.7% on the day. Guidance was for sale to –1% to 0%, better than the prior estimates of –1 to –3%.
The data refuses to all swim in the same direction from the US, as the latest initially weekly claims data matched an 8-month low at 190k, far lower than the 214k expected. The January Philadelphia Fed survey came out at –8.9, still a very negative number, but better than the –11.0 expected and the dire Empire Manufacturing survey reading from a few days before. US Housing starts came in a touch stronger than expected at an annualized 1382k than expected and Building Permits a bit weaker. For perspective, the housing starts number, while down from the peak of 1805k in April of last year, is still just above the range from 2008-2019.
Lael Brainard (voter) said the recent downshift in the pace of rate hikes allows the Fed to assess more data as it moves policy to a "sufficiently restrictive" level, noting we are now in "restrictive" territory and are probing for a sufficiently restrictive level. She didn’t clearly confirm a 25bps rate hike for February, but hinted at that saying Fed downshifted the rate hike pace in December to absorb more data, and that logic is applicable today. Another voter Williams is speaking in the Asian morning hours and signalling that the Fed has more work to do but labor demand far exceeds supply. Non-voter Collins reaffirmed her view that rates need to rise to likely just above 5%, and then the Fed needs to hold rates there for some time, also saying that it is appropriate to slow the pace of hikes particularly with risks now more two-sided.
Earlier this week, we have learnt that China reached its demographic peak with 10-year ahead of projections. This will serve a as wake-up call for other countries, certainly. The world population growth is now below 1 % for the first time since the first half of the 20th century. About 61 countries in the world are expected to see their population decrease by at least 1% by 2050 (the population of Japan has been declining since 2010 while that of Italy since 2014, for instance). Expect massive consequences for the labor market. In Germany, about 500,000 people will leave the labor market each year between 2025 and 2035. This is massive! We are entering into a world of human capital shortage.
The December report out this morning showed volumes declined –1.0% MoM and –5.8% YoY including Auto fuel and ex Auto fuel were –1.1% MoM –6.1% YoY.
Japan’s December CPI came in at 4.0% YoY from 3.8% YoY previously, with core CPI also at 4.0% YoY while the core-core measure was a notch softer-then-expectations but still above the 2% target, coming in at 3.0% YoY. Despite the Bank of Japan’s pushback on expectations to tweak policy this week, speculations are likely to continue as inflation breadth is spreading. A contender to succeed Bank of Japan Governor Kuroda, Takatoshi Ito, said that the BOJ's next step may be to widen 10y band, could raise it to 0.75% or 1.00% by mid-year, likely won't tweak yield curve control at least until April, and may abandon negative rates this year depending on inflation and wage developments.
In energy, Haliburton will announce its result while the five western super-majors are expected to deliver record annual profits, starting with Chevron next Friday. US Steel and Freeport McMoRan will be watched on metals while the agriculture sector will be watching the result from ADM, one of a quartet of agriculture trading power houses, known as the ABCD’s, the others being Bunge, Cargill and Louis Dreyfus.
The Q4 earnings season continues today with two Swedish companies: mobile network equipment maker Ericsson, with its share price down some 50% from the peak and trading a few percent above the lows since 2018, and Sandvik, a company specializing in tools, machinery and applications related to metalworking and rock excavation. Its share price has seen a strong revival off late 2022 lows of some 30+%. Schlumberger also reports today and is the US’ largest oilfield services company.
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