- No less than 20 central banks met over the week to discuss monetary policy
- The Omicron variant continued to spread at a worrying pace
- The Fed considers the Omicron variant is more likely to increase inflation than cause growth to slow down
No less than 20 central banks met over the week to discuss monetary policy with some deciding to reduce monetary support even if the Omicron variant continued to spread at a worrying pace.
With US inflation accelerating to 6.8% YoY in November and the labour market continuing to recover, the FOMC decided to accelerate tightening. Amid so many inflation catalysts -oil prices, supply and production constraints, rising rents and wages- the Fed considers the Omicron variant is more likely to increase inflation than cause growth to slow down. As a result, it raised its inflation forecasts to 2.6% in 2022 and 2.3% the year after. Jerome Powell said asset purchasing would now be wound down in March with three rate hikes to follow in 2022, another three in 2023 and two in 2024. This should eventually take benchmark rates to 2.25%, or less than the neutral 2.5% rate. The FOMC also discussed shrinking the Fed’s balance sheet.
Meanwhile, the Bank of England surprised markets by raising rates, citing an acceleration in inflation and the strong labour market.
The spreading Delta variant weighed on the eurozone’s December’s PMI, especially in services and in Germany where they even moved into contraction territory. European gas prices hit another peak due to worries that the Russia-Ukraine dispute would get worse. The G7 summit reminded Moscow of the heavy sanctions it would face if Ukraine were to be invaded and issued an ultimatum to Iran to find an agreement on its nuclear development. Energy prices are a key component in strong inflation.
The ECB meeting confirmed that the PEPP would be wound up in March but said it could be reactivated if financial conditions deteriorated sharply. It also prolonged PEPP reinvestments up to end 2024 with some flexibility so as to limit peripheral country spreads. Greece, for example, could see more than its fair share of asset purchases. At the same time, the traditional asset purchasing programme (APP) will be raised by €20bn in April before being gradually whittled down to zero by the end of 2022. The bank sees no rate rise before 2023.
Central banks in Switzerland and Japan stuck with their accommodating stance but both countries have so far escaped significant inflation.
In China, industrial production recovered in November, up 3.8% over a year, due to international demand and improved access to commodities. However, consumption only rose by a disappointing 3.9%. A study suggesting the Sinovac vaccine offers very low protection against the Omicron variant raises the possibility that restrictions might be reinforced as part of the country's zero-Covid drive.
We are still neutral on equities and underweight government and investment grade bonds.
EUROPEAN EQUITIES
Market moves over the week were driven by central banks rather than news on the pandemic. First, Switzerland's central bank intervened to stop the Swiss franc rising too much and then the Bank of England raised its benchmark rate to 0.25%. As expected, the ECB said it would be winding up its pandemic purchasing programme (PEPP) but said it might be reactivated if needed. Elsewhere, the G7 once again said there would be massive consequences if Russia invaded Ukraine. A Russian official then said Moscow might be forced to deploy nuclear missiles in Europe due to their suspicions that NATO intended to do the same. These developments suggest there will be no immediate decision on the Nord Stream II project. As Russia is the main exporter, gas prices will therefore remain high.
In company news, Volkswagen said production in 2022 would be lower than this year due to semiconductor shortages. Airlines, led by Ryanair, said the spread of the Omicron variant would be bad for the sector over the short to medium term and they cut passenger traffic forecasts. EDF was forced to reduce its EBITDA guidance for the end of 2021 due to defects in two nuclear plants, including the Vienne site. Both have been shut down for repairs. In pharma, both the Sanofi and Valneva booster vaccines have had good results so there are hopes two French vaccines will soon be approved in Europe. The European Commission approved Veolia’s acquisition of Suez, providing Veolia’s disposals programme went ahead as planned. The deal should help the EU compete with Chinese firms in water and waste management.
US EQUITIES
In a mixed showing for indices, the Dow and S&P500 edged 0.4% and 0.03% higher while the Nasdaq shed 2.17% (as of Thursday evening).
Investors turned risk-off as Omicron variant cases accelerated and nerves were tested over central bank monetary stances. Production prices rose 9.6% YoY, or more than the 9.2% pencilled in by analysts and expectations rose for the Fed to turn hawkish. As a result, Jerome Powell’ post-FOMC comments, a balancing act between the need to combat inflation and support growth, were more or less expected. The Fed increased monthly tapering from $15 to 30bn with a view to winding up asset purchasing completely by March instead of June as initially scheduled. And most FOMC members now see 3 rate hikes in 2022; in September, half of them expected only two. The dot plots also see another 3 hikes in 2023 and 2 in 2024 to take benchmark rates towards 2.10%. The Fed also revised up its growth forecasts for 2022 from 3.8% to 4% and expects unemployment to fall to 3.5% (vs. 3.8% previously). It sees inflation at 5.3% this year and 2.6% in 2022.
In company news, Adobe slashed its guidance for 2022, triggering a sector sell-off.
Microsoft was also lower after the UK’s Competition and Markets Authority said it would be examining the proposed $16bn acquisition of Nuance (AI and speech recognition technology).
In contrast FedEx jumped 6% after the bell after raising guidance and unveiling a $5bn share buyback programme. The group benefited from raising prices before the Christmas period and said labour shortages had abated.
Uber gained 4.2% after its CEO said it was mulling the sale of its stake in its Chinese car-hire rival Didi.
Pfizer was higher after positive Phase II/III trials on its anti-Covid pill, Paxlovid.
Reddit, a social network platform with 430 million users, filed for an IPO. The company is aiming at a $10bn valuation.
Due to mounting Covid cases in the US, Apple pushed back plans for staff to return to the office.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX ended the period 1.19% and 1.12% high. Sentiment was initially hit after the prime minister mentioned possible restrictions on share buybacks but was lifted by the FOMC’s monetary policy pivot and by receding concerns over the Omicron variant. The Mothers index dropped 5.09% due to a temporary deterioration in supply and demand after a rash of IPOs in December.
Insurance, Marine Transportation and Transportation Equipment rose 4.73%, 3.02% and 2.79%, respectively. Air Transportation and Services declined 2.21% and 1.93% over continuing Covid-19 concerns. Real Estate was also down 1.71%.
Oriental Land jumped 8.46% thanks to the less serious Covid-19 situation and the effect of the year-end holiday season. Denso gained 7.84% on strong earnings and a business shift from hybrid to electric vehicles. Canon rose 7.63% on a recovery in digital camera sales and a dividend increase.
Z Holdings continued to fall, down 5.04% due to dilution risk from newly issued stock acquisition rights. M3 shed 4.71% on a broker downgrade.
The Bank of Japan’s monetary policy meeting decided to stop purchasing commercial paper and corporate debt by the end of March 2022 as scheduled. However, aid to loan providers was extended by six months to September 2022 in order to help small to medium-sized enterprises amid concerns over the Omicron variant.
EMERGING MARKET
The MSCI Emerging Markets Index closed down 1.14% in USD as of Thursday. Brazil outperformed, edging down 0.33%, while China (-3.7%) and India (-2.1%) underperformed.
In China, the annual Central Economic Work Conference (CEWC) ended on December 10th with a pro-growth stance for 2022. New home prices were down 0.33% MoM in November, after minus 0.25% in October. Year to date property investment was up 6% YoY. Retail sales increased 3.9% YoY, or below expectations of +4.7%. Industrial production, on the other hand, was slightly better than anticipated (+3.8% YoY vs. +3.7%). Chinese biotech and CXO companies suffered a sharp correction on rumours of a US entity list inclusion, but eventually recovered as the published list did not include any listed biotech companies. Shimao’s dollar bonds rose sharply Friday amid signs that authorities want to prevent a cash crunch at the developer, with China’s financial regulator coordinating negotiations with trust firms for loan extensions. Weibo was fined another RMB 3m for cybersecurity violation, in addition to a combined RMB 14.3m already imposed this year. Trip.com’s third-quarter results beat market consensus but its forward outlook remained clouded by the Covid resurgence.
In Taiwan, TSMC reported November sales up 10% MoM and 19% YoY for its third highest monthly sales figure and best November ever.
In India, October’s industrial production grew 3.2% YoY (+3.8% YoY on 2Y CAGR), or in line with estimates. November CPI inflation rose to 4.9% YoY from 4.5% last month, or lower than estimates of 5.1%. Net inflows into Indian mutual funds were Rs116bn in November, or more than double October inflows, marking a ninth straight month of inflows. TVS Motor announced a partnership with BMW to produce electric two-wheelers.
In Brazil, the Copom minutes reiterated the Central Bank’s hawkish tone as long term inflation expectations inched higher. Congress promulgated the final part of the Precatorios Bill, which provides BRL 43.8bn for expenses (plus BRL 62.2bn, totalling BRL 106bn for expenses). Ex-Sao Paulo governor Geraldo Alckmin made his departure from the PSDB party official, with press reports stating he is likely to run for Vice President next year behind Lula. The antitrust authority approved Localiza’s acquisition of Unidas, a deal that could create one of the largest car rental companies in the world.
Mexico’s central bank unexpectedly accelerated the pace of interest rate increases, a hawkish move that seeks to contain inflation. As expected, Chile’s central bank hiked its overnight rate by 125bp to 4% and delivered hawkish guidance. All attention is now focused on the December 19 presidential election.
CORPORATE DEBT
CREDIT
Credit markets moved higher in a week where the Fed announced that it would speed up tapering, ending its asset purchases three months earlier in March 2022 and then raising rates three times over the year. The ECB said it would wind up its PEPP at the end of March too but decided to increase its normal asset purchasing programme. The news sent 10-year US Treasury yields 7bp lower while the yield on the equivalent German Bund dropped by 2bp to minus 0.37%. The Xover and Main tightened by 10bp and 2bp leaving high yield bonds 0.04% better over the period and investment grade 0.02% lower.
The new issues market went quiet ahead of the Christmas period both for corporate debt and subordinated financial debt. In bank news, BPER Is considering buying Banca Carige from the FITD on very similar terms to those UniCredit is demanding for Monte Paschi.
CONVERTIBLES
The new issues market maintained momentum with two new issues in the US.
Luminar Technologies raised $550m at 1.25% with a 2026 maturity. The company makes advanced sensors for autonomous vehicles. Biotech Global Blood Therapeutics raised $345m at 1.875%. The company is known for its treatment for sickle cell disease (drepanocytosis).
In company news, EDF revised profitability lower after two reactors in its Chooz nuclear plant in the Ardennes region were shut down to check emergency cooling processes. This, and the shutdown of two reactors in its Civaux plant, will mean a loss of around 1TWh by the end of this year. The group is now forecasting EBITDA of €17.5-18bn, down from above €17.7bn previously. There was also bad news at Cellnex (telecom infrastructure). The UK’s competition watchdog (CMA) said the acquisition of 24 600 telecom towers from CK Hutchison raised concerns, citing a possible increase in prices and reduced service for network operators.
GLOSSARY
- Investment Grade: bonds rated as high quality by rating agencies.
- High Yield: corporate bonds with a higher default risk than investment grade bonds but which pay out higher coupons.
- Senior debt benefits from specific guarantees. Its repayment takes priority over other debts, known as subordinated debt.
- Debt is considered to be subordinated when its redemption depends on the earlier payment of other creditors. To offset the higher risk, subordinated Senior debt has priority over other debt instruments.
- Tier 2 / Tier 3 : subordinated debt segment.
- Duration: the average life of a bond discounted for all interest and capital flows.
- The spread is the difference between the actuarial rate of return on a bond and the rate of return on a risk-free loan with the same maturity.
- The so-called "Value" stocks are considered to be undervalued.
- Markit publishes the Main iTraxx index (125 leading European stocks), the HiVol (30 highly volatile stocks), and the Xover (CrossOver, 40 liquid and speculative stocks), as well as indices for Asia and the Pacific.
- EBITDA: Earnings before Interest, Taxes, Depreciation, and Amortization.
- Quantitative easing describes unorthodox monetary policy from a central bank in exceptional economic conditions.
- Stress Test: a process which simulates extreme but possible economic and financial conditions so as to assess any impact on banks and measure their resilience to these events.
- The PMI, for "Purchasing Manager's Index", is an indicator of the economic state of a sector.
DISCLAIMER
17/12/2021
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