Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Chinese stimulus constraints, FedEx hit by lower volume
Peter Garnry
Chief Investment Strategist
Summary: Expectations for Chinese stimulus have been driving Chinese equities higher in June but PBoC disappointed the market today cutting the policy rates by 10 basis points against the consensus estimate of 15 basis points underscoring that Chinese stimulus is not happen as fast and big as the market wants. FedEx earnings tonight is the next release on our earnings watch and analysts have low expectations for revenue growth so investors will be focusing on the company cost cutting execution which is key for improving profitability while volume growth remains challenged.
Key points in this equity note:
- Expectations for Chinese stimulus have clearly been too high and the PBoC’s 10 basis points rate cut was another disappointment.
- Chinese equities will continue to suffer relative to other countries benefitting from changing global supply chains and the government will be more constrained in its stimulus policies compared to past cycles.
- FedEx reports earnings tonight and investors will focus on the company’s ability to deliver on its plan to reduce costs. The outlook is quite muted due to lower volume as inflation has reduced volume demand in the global economy.
PBoC disappoints market with 10 bps rate cut
Chinese equities have rallied in June based on rising expectations that the Chinese government will soon do a lot more stimulus to backstop demand and ensure higher economic activity. However, PBoC’s 10 basis points rate cuts across its key benchmark rates were lower than the 15 basis points expected sending Chinese equities lower and denting general risk sentiment across equity and commodity markets.
Since the peak of the weakest technology segments in February 2021, the larger and more mature part of the technology sector peaked later in November 2021, Chinese equities have underperformed countries such as Mexico, South Korea, India, Malaysia, Japan, Indonesia, and Vietnam. These countries are those we find gain the most from fragmenting supply chains and de-risking of Chinese manufacturing. De-risking of supply chains, more strict Covid-19 policies, clampdown on the private sector, and a real estate sector in distress are all factors behind the Chinese underperformance. The fragmentation game that we described in our Q2 Quarterly Outlook is a long-term trend that will continue to play out in favour of those countries mentioned above.
Our view is that China’s debt overleveraged economy has created constraints on the government’s ability to easily reignite economic growth and that the country will go through a prolonged adjustment reducing debt leverage and reducing reliance on exports to drive the economy.
Lower volume to hit FedEx
FedEx is the next major earnings release to watch scheduled tonight after the US market close. Analysts expect revenue in FY23 Q4 (ending 31 May) of $90.9bn down 3% y/y and EBITDA of $9.5bn down from $10.2bn as the logistics company is hit by lower volume. Cost cutting execution is a key parameter for investors going into the earnings release as FedEx must improve profitability. Early signs that management’s cost cutting is working were sign back in March when the company raised its FY23 EPS guidance to $14.60-15.20 from previously $13-14.
Volume growth is expected to remain negative in FY24 Q1 (ending 31 August) and FY24 revenue estimates are at $91.2bn up only 0.3%, and even worse the current FY24 revenue estimates are down more than 10% compared to where they were back in April 2022. The honeymoon for logistics firms during the pandemic with strong pricing power on top of higher volume is over and the emphasis is now on cutting costs. FedEx is aiming to reduce costs by $6bn by FY27 and part of this plan is to increase rail transportation to 15% from 8% as rail costs are lower than trucking.
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