- As expected, the Fed left rates unchanged.
- We will need to see less vigorous economic data if the final disinflation lap is to be completed.
- We are still closely watching the main risk, i.e. the impact of potential rate rises.
As expected, the Fed left rates unchanged. Jerome Powell said markets would need to be patient as little progress had been made on the disinflation front since the beginning of the year, and especially not in services. But investors were happy to hear that he had ruled out any further rate hikes. The Fed’s conventional policy will therefore continue but the bank offered some compensation by slowing the pace of quantitative tightening. This FOMC seemed to be telling us that the Fed put was back. In other words, the Fed would ride to the market’s rescue and provide sufficient liquidity if growth and the jobs market were to turn lower.
We will need to see less vigorous economic data if the final disinflation lap is to be completed. The US is still strong, and notably domestic consumption. However, manufacturing ISM moved back into negative territory. The JOLTS programme showed that the labour market was genuinely easing. The Great Resignation, or Big Quit, phase seems to be over. Resignations have returned to pre-Covid levels and new job openings are falling back.
In the eurozone, the growth/inflation mix should help interest rate cuts come sooner.
A European Commission survey noted that sales prices were still trending lower so we could see more disinflation without modest growth being affected. Business confidence surveys like PMIs and Germany’s IFO suggest the situation is improving.
And a Gaza ceasefire could boost disinflation by sending oil prices lower.
We are still closely watching the main risk, i.e. the impact of potential rate rises. But the Fed will want to avoid a major monetary policy blunder in a presidential election year by raising rates. As a result, the environment is still upbeat for risk assets, and equities in particular.
We are tactically overweight equities as they could start to rebound following an upbeat earnings season.
European equities
Autos, distribution and tech dragged down indices over the period. Underlying inflation started to show encouraging signs of slowing. In Germany and Spain it came in at 3% and 2.9%. The data warrant a more accommodating approach from the ECB, especially as business confidence fell in April due to manufacturing.
In earnings news, Spain’s BBVA fell despite upbeat results as investors had already factored in the news after Société Générale’s better-than-expected figures. Autos came under attack. Germany's Porsche missed expectations due to soft Chinese demand and competition from electric models. It was the same story at Mercedes-Benz, Volkswagen and Stellantis who also cited rising costs. In healthcare, Denmark’s Novo Nordisk raised its objectives for this year but investors eyed the risk of lower prices for its obesity drugs due to rival products from companies like Eli Lilly. In shipping, Maersk was hit by higher costs due to Red Sea disruption and persistent excess capacity problems. Management said these issues could continue up to the end of this year and probably next year too.
Carlsberg reported higher volumes, especially for beer ahead of the summer. There was more encouraging news in the basic resources sector from Imerys and ArcelorMittal which both reported beats and said they were optimistic for the rest of the year. German building software company Nemetschek had a good first quarter despite difficult conditions in construction. And as expected, France’s IT leader Capgemini reported a drop in sales but reaffirmed full-year guidance.
US equities
Wall Street ended the period almost flat. The S&P 500 dipped 0.6% and the Nasdaq 100 0.8%.
Following the FOMC, Jerome Powell’s comments were more dovish than expected even if inflation is expected to be higher than forecast this year. In earnings news, Apple jumped 6% in extended trading after announcing a huge $110bn share buyback programme. In healthcare, CVS’s results missed expectations and management cut full-year guidance by close to 20% due to more people using Medicare than expected.
It was a different story with GLP-1 makers: Eli Lilly raised full-year guidance, citing improved visibility on future production. Dentsply Sirona’s results were mixed with a sharp fall in the scanners division offsetting a recovery in Chinese demand. In insurance, earnings per share at AIG beat expectations and investors cheered a $10bn share buyback programme and a 40-cent rise in the dividend.
Results at Kellanova (ex Kellogg’s) highlighted strong inflation among consumer products. Volumes fell 3% but like-for-like sales were up by more than 5%. This week's surprise came from Carvana (auto sales) which continued on its impressive stock market surge thanks to its cost-cutting strategy. In the payments processing sector, Block benefited from improved margins and last year’s successful attempts at cutting costs.
Emerging markets
The MSCI EM index was up 1.13% this week as of Thursday. China (+2.45%) continued on its strong rebound. India and Korea advanced 1.33% and 1.26%, respectively. Brazil and Taiwan rose 0.82% and 0.23%, respectively.
In China, official and Caixin (private sector) manufacturing PMI for April were 50.4 and 51.4, both ahead of consensus expectations. Industrial profits have risen 4.3 % YoY since the beginning of the year but declined 3.5% in April. The Politburo is shifting the focus to destocking housing inventory and deploying government funds to buy commercial residential buildings to repurpose as affordable housing. Several top-tier cities including Beijing, Shanghai and Tianjin announced further moves to ease property policies. The Ministry of Commerce published details of incentives for its vehicle trade-in programme. Midea’s first-quarter earnings were in line and with record operating margins. The company also announced a secondary Hong Kong listing. First-quarter profits at China Merchants Bank were as expected and pressure on NPLs eased.
In Taiwan, GDP expanded 6.51% in the first quarter, or more than the 6% expected. Factory activity expanded for the first time in two years, with Manufacturing PMI for April improving to 50.2 from 49.3 in March. Mediatek reported a fourth-quarter 2023 beat on a one-time cost reversal gain and management is bullish on the growth potential of AI ASICs.
In Korea, exports rose for the 7th consecutive month in April, rising 13.8% on strong chip demand. Industrial production in March grew 0.7% YoY, largely missing the 4.6% rise expected. The capital market institute announced a second “value up” programme, focusing on guidelines for corporate disclosures. First-quarter figures at Samsung Electronics were in line with strong prospects for AI driving up demand for HBM and eSSD.
In India, manufacturing PMI remained strong at 58.8 in April vs. 59.1 in March; the pace of output and new order rises were the second highest in more than three years. GST revenue collection was up 12.4% YoY to an all-time high of $25bn in April. In its fiscal 2Q24 conference call, Apple’s management said, “India is growing in the strong double digits and is a major focus for Apple”. ICICI bank reported a beat on higher NII, improving asset quality, lower provisions and a better cost-to-income ratio. HCL reported an inline quarter but weak guidance for FY25. Havells had a strong quarter with traction on the industrial portfolio and an improved contribution margin at Lloyd.
In Brazil, manufacturing PMI in April strengthened to 55.9 vs 53.6 in the previous month. FDI for March was $9.5bn, ahead of estimates of $6.8bn. IPCA 15 inflation grew 0.21 % MoM, or below the 0.29% estimated. Mercado Libre reported strong 30% sales growth of and a 12% EBIT margin, or better than expected. Bradesco reported a beat on lower provisions but ROE continued to decrease. WEG reported weaker top line growth driven by softness in foreign end markets but the EBITDA margin was a positive surprise.
In Mexico, manufacturing PMI in April came in at 51 vs. 52.2 in the previous month. Results at Arca Continental beat expectations on a higher EBITDA margin in the US and Mexico. Prices in both countries rose 5%.
In Argentina, omnibus and fiscal reforms were approved in the lower house and will now go to the Senate.
Corporate debt
Credit
April ended with a series of macro data showcasing the vigorous US economy. Risk-free rates logically pushed higher towards year highs. Retail sales for April also largely surprised on the upside, the labour market stayed strong and the CPI remained rooted around 3.5%. Most importantly, core PCE came in at 3.7%, or 0.2% above expectations. True, GDP also slightly missed expectations but the consumption component remained strong, another token of economic momentum. Fed chair Jerome Powell no longer seems to be in a hurry to cut rates and markets gradually pushed back rate cut expectations over the month from July to September and then to November. At the same time, eurozone PMIs underpinned the soft landing scenario. Manufacturing was a disappointing 45.6 but services, an important indicator in Europe, rose to 52.9, a sign that activity was enjoying something of a rebound. GDP is now expected to grow by 0.5% this year so any risk of a strong, prolonged recession is increasingly unlikely.
Yields on 10-year US Treasuries had kicked off the month at 4.2% but finished at 4.68%, a level not seen since the middle of November. Yields on the equivalent German Bund rose from 2.30 to 2.58% over the same period. For 2-year maturities, yields rose from 2.8% to above 3% in Germany and from 4.6% to above 5% in the US.
Spreads were unchanged over the month despite a bout of volatility in the middle of the month when they widened briefly. Thanks to inflows and dynamic new issuance, investment grade spreads stayed at 112bp, the low end of the 5-year average spread of 130bp. High yield spreads ended the month at 350bp after a fleeting move to 375bp. New IG and HT issuance amounted to €50bn, taking YTD issuance to €275bn.
Investors are still keen on overall returns and less on absolute spreads. Strong demand has continued to help coupons tighten from initial indications. New high yield deals included Iliad, Verisure, Mahle and Volvo. Investment grade issues included Goodman and General Motors. In subordinated financial debt, the week saw deals from IB with an AT1, Credit Mutuel Arkea, Commerzbank and Achmea (T2) and Eurobank and Bank of Cyprus (Senior).
In a market ruled by interest rate volatility, all bond market segments lost ground over the month. Hit by long sensitivity over 7, the Euro Government Bonds index fell 1.4% (-2.06% YTD). Investment grade shed 0.84% (-0.44% YTD) and High Yield edged only 0.03% lower thanks to its short duration profile (around 3) and high yield carry. Year to date, high yield is still up 1.6%.
Convertibles
Returns over the week were slightly negative due to US equities underperforming.
All eyes were on the FOMC decision. Rates were left unchanged but chairman Jerome Powell struck a dovish note by ruling out a rate hike in the future and promising a reduction in the pace of quantitative tightening His comments triggered a rally.
In this week’s company reports, sales at Eli Lilly missed expectations slightly but results rose and the group raised its full-year outlook. The stock gained more than 3%.
Global Payments tumbled by more than 10% after first-quarter operating margins came in below expectations. In contrast, Worldline jumped 10% after electronic payments grew more than analysts expected.
European auto stocks had a bad week. Like Stellantis and Volkswagen, Mercedes shed more than 5% after its adjusted EBIT came in 5% below expectations. However, management stuck with guidance as the first quarter is considered as a sales and margin low point.
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.
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03/05/2024
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