- The Fed unsurprisingly raised its benchmark rates in its effort to tame inflation
- Geopolitics also contributed to market worries
- We are still cautious on risk assets
It was another difficult week for markets. After saying goodbye to Queen Elizabeth II, the focus turned to the week’s central bank meetings in Sweden, Japan, Switzerland, the UK and several emerging countries. The most important, the Fed, unsurprisingly raised its benchmark rates in its effort to tame inflation. It was the third 75bp hike and took the total to 300bp in 6 months, the most aggressive tightening cycle in its history.
Investors had anticipated the move but Jerome Powell’s words surprised them. He was resolutely hawkish, reiterating the Fed’s inflation target of 2% and saying that a soft landing was now less probable. He said the property market needed to correct and that the Fed would accept a bigger surge in unemployment if inflation were to remain high. The dot plot rose significantly to 4.4% at end 2022 and 4.6% in 2023.
Switzerland’s national bank joined the 75bp club; markets had been hesitating between 75 and 100bp. Sweden was the most aggressive, hiking by a full percentage point. In the end, the Bank of England chose to go for a moderate 50bp rise due to the weak economy and ahead of a new tax plan. Even so, the bank reminded investors that the tightening cycle had further to go. Only the Bank of Japan abstained by sticking to the status quo. The yen then fell further and the bank had to intervene to prop it up. Japan’s prime minister Fumio Kishida said the bank would continue to act if the yen were to suffer more big swings.
Geopolitics also contributed to market worries. Vladimir Putin's decision to mobilise reserve troops heightened fears that the Ukraine conflict would worsen and last longer. All risk assets -equities, government bonds, corporate debt and currencies- ended the period lower. Declines were accentuated on Thursday when US employment figures came in better than expected, sending Treasury yields even higher.
Given the circumstances, we are still cautious on risk assets. We now have a more balanced geographical stance on equities, especially in the US and Europe. We are cautious on US equity valuations as financial conditions tighten. European equities are cheaper but the current environment will put pressure on earnings in coming quarters. We are still underweight duration, especially in Europe, and prefer US bonds.
EUROPEAN EQUITIES
Markets traded in line with interest rate hikes. Sweden's central bank raised its key rate 100bp to 1.75%, or more than the 75bp expected, but the Bank of England only announced a 50bp rise, admittedly without a large majority in favour. Norway's central bank also raised rates by 50bp to 2.25% but said the next moves would be more gradual.
Economic data was less contrasted. Producer prices in Germany accelerated to 7.9% MoM in August, or much more than the 2.4% expected and up on July’s 5.3%. In France, business sentiment in manufacturing fell to 102, down from August’s revised reading of 103 and eurozone consumer confidence fell to minus 28.8 compared to minus 25 in August. The UK delivered the first details on its £40bn stimulus plan to help companies cope with the energy crisis. It aims to cap gas prices at £75/MWh and electricity at £211/MWh from October to March, a decision which looks unlikely to quell inflationary pressure.
In company news, Engie’s chairman said industries had cut gas consumption by 30% after price rises, confirming that natural gas shortages had had an impact but offering some reassurance on the capacity to adapt. Germany decided to nationalise Uniper following the group’s struggle to deal with gas price rises. Deutsche Bank said higher interest rates would largely offset any losses from macroeconomic difficulties. Italy’s UniCredit also said it would be revising guidance higher when it announces it quarterly results.
In M&A, Schneider is to bid around 3,100p to take its stake in the UK’s Aveva to 100%. Despite the danger of recession, Vallourec signed a 10-year contract to provide Saudi Aramco with premium casing and services.
US EQUITIES
Unsurprisingly, the Fed raised its rates again by 75bp. However, Jerome Powell’s unambiguous message that this was the price to be paid to curb inflation weighed on sentiment. The S&P500 and Nasdaq tumbled 3.67% and 4.20%. And fears of a global slowdown were only reinforced by the almost concomitant move to raise rates in countries like the UK, Switzerland, Norway, Indonesia, the Philippines and Taiwan. Swap contracts now expect US benchmark rates to peak at 4.5% in 2023, up from 3.5% after the July FOMC.
Nouriel Roubini, the economist who predicted the 2008 meltdown, warned that the world could be in for a painful recession from the end of this year and that it could last throughout 2023. He thinks the size of corporate and household borrowings will mean a significant impact from higher interest rates. He now sees the S&P falling a further 30%, and even 40% should a hard landing occur.
Elsewhere, US home builder sentiment fell from 49 in August to 46 in September, its 9th drop in a row. The index was at 55 in July and 67 in June.
In company news, Ford fell 5.9% in afterhours trading following a profit warning. The company said its EBIT margin would contract significantly over this quarter due to higher prices from suppliers, $1bn more than expected, and supply chain disruptions.
Coty (cosmetics) gained 3.2% after raising guidance on sales growth for the first quarter of 2033 from 6-8% to 8-9%. Margin guidance was also revised higher. The group is even expecting skin care sales to double by 2025.
Fedex rallied after unveiling a $2.2-2.7bn cost-cutting plan and a 6.9% rise in prices from January 1st. This comes after a 5.9% increase earlier this year.
After a testing day for tech stocks, Microsoft advanced after its CEO Satya Nadella said he was confident its acquisition of video game maker Activision Blizzard would be completed successfully.
Appearing before a Congressional panel, JP Morgan’s CEO Jamie Dimon lashed out at cryptocurrencies, comparing them to a decentralised Ponzi pyramid scheme.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX dropped 2.02% and 1.52% for the period, going risk off due to the FOMC and following US and Chinese equity markets lower. There was, however, some hope for stimulus measures to help the Kishida administration’s ratings, down sharply in a September survey.
Insurance and Banks gained 2.23% and 1.64% on rising US rates and the September 29 ex-dividend date. Pulp & Paper rose 0.40%. Marine Transportation fell 3.28% on global economic concerns after FedEx withdrew its earnings guidance. Precision Instruments and Electric Appliances declined 3.14% and 2.67% on profit-taking.
Dai-ichi Life Holdings and Resona Holdings gained 3.05% and 2.85% on higher bond yields in the US and Europe. Kirin Holdings rose 2.72% on a broker upgrade praising its efforts to diversify profit drivers and increase prices in Japan. M3, Tokyo Electron and Z Holdings tumbled 5.85%, 5.54% and 4.60% as high tech and semiconductor stock valuations were undermined by rising long bond yields in the US.
The yen remained weak, trading between 142 and 145 against the dollar after the Fed raised its benchmark rates.
The Ministry of Economy, Trade and Industry (METI) and Ministry of the Environment (MOE) are working on establishing rules on how to measure carbon footprints. The outline will be produced by the end of October and the guideline is going to be put together by the year end.
EMERGING MARKETS
The MSCI EM Index was down 2.2% as of Thursday’s close. Brazil rebounded by 6.2%. China (-3.8%) underperformed while India edged 0.9% lower.
In China, daily trading turnover for A shares slumped to an October 2020 low with Shanghai & Shenzhen turnover shrinking to RMB 655bn ($93.3bn) on Sept 21st. The PBoC kept both 1-year and 5-year LPR unchanged. Foreign Direct Investment was up 16.4% YoY YTD. The US Senate Foreign Relations Committee passed the Taiwan Policy Act 2022, providing Taiwan with $6.5bn for military equipment. China sent a team of CSRC and MOF officials to Hong Kong to assist with the US regulator’s onsite audit inspections of Chinese companies in a process expected to last for 8-10 weeks. Shanghai announced 8 infrastructure projects for a total investment of RMB 1.8 trillion ($257bn). Zhengzhou city reportedly lowered down payments for second home purchases to 40% from 70% previously. Chengdu, a city of 21 million people, lifted a weeks-long lockdown. Li Auto announced an early launch of its six-seat SUV named Li L8 on Sept 30. Trip.com announced better-than-expected second quarter results with pent-up domestic demand and an international recovery in its third-quarter guidance.
Hong Kong is to end mandatory hotel quarantine for overseas arrivals. AIA is reportedly in advanced talks to acquire Philippine firm Medicard.
Taiwan’s August exports rose 2% YoY, or higher than the 1.1% expected. Exports to China fell more than 20% YoY, while exports to the US and Europe held up.
The Philippines central bank raised its key rate to 4.25%, in line with expectation.
In India, Adani will double its cement capacity by 2027 after the acquisition of Holcim’s assets.
Brazil’s central bank held the benchmark interest rate unchanged at 13.75%. Inflation cooled to 8.73% in August from a peak in April on lower oil and commodity prices. August’s formal job creation was 260,000 or more than the 219,000 expected. Petrobras is to reduce diesel fuel prices by 6%. The Brazilian Development Bank approved funding for 19 MW in solar projects.
CORPORATE DEBT
CREDIT
The FOMC meeting and news on the Ukraine conflict continued to influence trading. The Fed raised rates by 75bp and eurozone bond yields also moved higher. Yields on 10-year Treasuries hit 3.72% and the equivalent German Bund flirted with 2%. High yield credit premiums remained more or less stable at 550bp. However, the Xover, a good indicator of risk appetite as it is synthetic and used to gain exposure or hedge positions, rose by close to 70bp, 20bp of which was due to technical index adjustments.
Investment grade premiums in Europe edged higher towards 200bp. Reflecting higher volatility after Vladimir Putin’s aggressive declarations, subordinated bank debt premiums rose sharply to 910bp for Euro CoCos, almost a year high. Higher rates and credit premiums took bond yields close to year highs: 3.8% for top-rated companies, 7.5% for high yield and close to 9% for CoCos.
CONVERTIBLES
New issuance took a breather due to poor market conditions, with investors focusing on geopolitical issues and the FOMC. Convertibles showed resilience as equity markets fell, thanks to their structurally low interest rate sensitivity helping them cushion declines more than other bond segments.
In M&A news, Schneider Electrics launched a bid on the 41% it does not yet own in the UK’s Aveva. The bid values the tech company at €11.65bn and will help Schneider complete its energy software portfolio.
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
23/09/2022
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