- Christine Lagarde is preparing markets for a 125bp rise by the end of 2022
- The ECB’s announcements have rekindled worries over fragmentation
- We are still negative on European risk assets
The ECB's monetary policy committee met during the week. There was no change to the calendar so we will not see any rate hikes before asset buying stops but the road map was clarified. Asset buying will cease on July 1st even though not all the sums allocated have been used. This will be followed by a 25bp hike in benchmark rates on July 21 and a possible 50bp rise in September.
Before the Ukraine war started, chair Christine Lagarde had tried hard to convince investors that short-term rates would remain unchanged this year. Now she is preparing markets for a 125bp rise by the end of 2022.
Risk assets fell on the news and the euro dipped to 1.06 against the US dollar. Peripheral country spreads widened and European and US equities lost ground.
The path to normalisation is reminiscent of the ECB’s last move to raise rates back in 2011 (25bp in March and another 25bp in July). European inflation then was essentially imported and oil had broken above $120. The situation is the same today.
In 2011, tightening sent the euro lower but it was trading above 1.50 against the dollar, and German-Italian spreads jumped from 190bp to more than 500bp. Today they are at 220bp.
Europe and especially its banks, are unquestionably more robust today but the ECB’s announcements have rekindled worries over fragmentation. The ECB’s only response is to promise that keeping eurozone country rates within some reasonable spread is a priority.
It will be tricky for the ECB to achieve this as it only has rates to play with but three objectives: (i) getting inflation back to its 2% target (at some time in 2024), (ii) shoring up the euro as its current weakness is fuelling imported inflation and (iii) keeping peripheral spreads within reasonable bounds.
We are still negative on European risk assets. We prefer Chinese equities because they are more attractively valued and we expect Beijing to adopt accommodating monetary and budgetary policies to help the economy emerge from lockdowns. The Fed is ahead of the ECB in its tightening schedule so we think US bonds offer more protection than European bonds.
EUROPEAN EQUITIES
Indices ended 3% lower over the period as worries mounted on the resilience of Europe’s growth cycle. This followed news that both the OECD and World Bank had cut their growth forecasts for this year, citing risks from persistent inflationary pressure. At the same time, new car sales in the UK in May were 21% down on the same month in 2021. The ECB then announced that it had raised its inflation forecasts and intended to stop its asset buying programme by July. Its chair Christine Lagarde also said benchmark rates would be raised in the coming months.
In company news, results at Soitec (semiconductor materials) were in line with guidance. The company said it would be expanding manufacturing in its Singapore factory. Scandal-hit Orpea (retirement homes) released the results of its audit into alleged mistreatment. The report said that although some allegations had not been proved, there had effectively been mistreatment and misconduct. Supermarket chain Carrefour was given the regulatory green light to complete its acquisition of Grupo BIG in Brazil. In healthcare, Sanofi’s treatment for infantile atopic eczema was approved by regulators. In an area we rarely comment on, OL Group which runs Lyon’s football club, said it was in discussions with investors interested in taking a stake in the group. American investor Foster Gillett’s name has been mentioned in press reports.
US EQUITIES
Indices fell back again over the period, leaving the Dow, the S&P500 and the Nasdaq down 2.93%, 3.81% and 4.57% on investor nerves ahead of the consumer inflation data. Expectations are for prices to have risen 8.3%.
Treasury Secretary Janet Yellen told a Senate hearing that inflation was running at unacceptable levels. She argued for appropriate budgetary means to help assuage inflationary pressure without harming the economy. Secretary of Commerce Gina Raimondo told CNN that lifting import duties on certain Chinese products could help reduce inflation.
Fed Fund futures now indicate a 72.5% probability that the Fed will hike by 50bp at the June, July and September FOMC meetings.
The World Bank once again cut its global growth forecasts to 2.9%, down from 3.2% in April and 4.1% last January. The OECD followed by slashing its forecasts from 4.5% (December 2021) to 3% for this year and to 2.7% in 2023. The organisation also expects inflation to be close to 9% this year.
WTI oil gained 1% to $120 as markets turned nervous again and energy stocks rose.
In company news, department store chain Kohl’s jumped 9.5% after the Wall Street Journal said the company was in talks with Franchise Group over its $8bn bid. Kohl’s is currently valued at $5.8bn.
E-commerce platform Shopify rose 5.5% on Thursday after a 10-for-1 stock split. Amazon gained 2% after a 20-for-1 split designed to make the share more accessible.
Twitter dipped 1.5% after Elon Musk accused the company of covering up the number of fake accounts and spams. The market is worried he might walk away from his bid.
At its annual developers conference, Apple unveiled new features for its iOS, macOS and iPadOS architecture. They include the ability to use Apple Pay to buy on credit (Buy Now, Pay Later). There will also be new versions of the MacBook Air and MacBook Pro laptops.
Bloomberg said crypto platform Coinbase was to freeze hirings and had rescinded job offers to people who had resigned from Goldman Sachs, Morgan Stanley, Blackrock, Wells Fargo and Citi to join the company.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX rose 3.04% and 2.21% for the period thanks to China ending lockdowns and reduced fears of global stagflation after the US released strong employment statistics. Even so, commodity and food prices continued to rise, rekindling concerns over further interest rate hikes and pushing markets lower. However, Japanese stocks were supported by the status quo in monetary policy and non-domestic inflows from investors looking to capitalise on the weak yen and find bargains.
Mining and Oil & Coal Products surged 15.22% and 10.56% respectively, as commodity prices kept on rising despite the OPEC+ agreement to increase production. Wholesale Trade gained 5.05%, again on higher commodity prices. In contrast, Marine Transportation sank 9.36%. Securities & Commodities and Insurance declined 1.28% and 1.19% respectively on profit taking after a 2-week rally.
Fast Retailing jumped 10.58% after sales in May increased by 17.5% YoY. M3 Inc., a medical information site operator, surged 9.08% after buying a Spanish company that provides smartphone applications for doctors. ENEOS Holdings rose 9.03% on rising oil prices. On the other hand, Dai-ichi Life Holdings and Nomura Holdings fell by 2.80% and 2.57%, respectively, on profit taking. Nitori Holdings lost 2.67% on concerns the weak yen would lead to higher costs.
The yen fell against almost all major currencies, hitting a 20-year low of 134 against the US dollar.
EMERGING MARKETS
The MSCI EM Index had edged 0.64% higher this week as of Thursday’s close. China continued to rebound, rising 5.88% in USD on Shanghai’s reopening and more signs of regulatory easing on tech sectors. India closed flat, while Brazil tumbled 6% as investors worried about more government spending to subsidise fuel prices.
In China, export growth accelerated significantly to 16.9% YoY in May vs. 3.9% in April. Consensus expectations were for an 8% rise. Import growth also surprised by bouncing to 4.1% YoY. May CPI was up 2.1% YoY and PPI up 6.4%, or in line with expectations. China is easing regulatory crackdowns on its tech sector, with another 60 new online games receiving approvals. The regulator is reportedly to conclude a yearlong probe into ride-hailing giant Didi and lift the ban on new user registrations. The CSRC denied rumors of trying to revive the Ant IPO, although it supports eligible platform companies going public in China and overseas. Biden declared a 24-month tariff exemption for solar panel products from several Southeast Asian countries. Daily volume in Shanghai's shipping and airline ports recovered markedly to more than 90% of normal levels. May retail passenger car sales were down by 17% YoY but recovered sequentially to +30% vs. April. BYD is to supply batteries to Tesla. Nio’s first-quarter sales and revenues were in line but earnings missed due to higher battery costs. The strong outlook for June sales suggested a rapid production recovery as Shanghai and the surrounding provinces reopen from COVID restrictions.
In Taiwan, May CPI reached 3.39%, a 10-year high. TSMC maintained its full year outlook at its shareholder meeting and expects sales to rise 30% this year, or more than before, thanks to resilient demand for electronics and EVs amid macro uncertainty. Airtac’s May sales rebounded by 19% YoY on alleviated COVID control measures in China.
In Thailand, CPI rose 7.1% YoY in May, up from 4.7% last month, and above expectations (+5.9%).
In India, the RBI raised the repo rate by 50bp to 4.90% in a unanimous decision. Inflation forecasts for FY23 was revised up to 6.7% from 5.7% and will remain above the 6% tolerance band in the first 3 quarters. India is looking to double Russian oil imports as state owned refiners are eager to benefit more heavily discounted supplies. Reliance and US private equity fund Apollo Global Management teamed up to make a £5bn bid for the Boots chain in the UK.
In Brazil, the government proposed fuel subsidies to contain a steep rise in fuel costs and remedy inflation pain. May IPCA inflation came in lower than expected (0.47% versus 0.6% consensus and 0.59% in April). Brazil is set to give up its controlling stake in Eletrobas, Latin America’s biggest power utility, through a share sale that could raise $7bn, the country’s largest privatisation in over two decades. PagSeguros reported better-than-expected 1Q22 Ebitda and net profit as well as 2Q guidance for revenues, but the market reacted negatively on a significantly higher capex number. Itaú announced that it had sold 1.21% of its stake in XP for less than the acquisition price.
As expected, Chile’s central bank raise rates by 75bp to 9% to rein in rising inflation.
CORPORATE DEBT
CREDIT
Investors focused on the ECB’s monetary policy meeting.
As expected, asset buying will be wound down on July 1st followed by a series of rate hikes starting later that month designed to curb inflation. This is an about-turn in the ECB’s approach. Bond yields rose, with 10-year US Treasuries adding 10bp and Germany’s equivalent Bund 14bp. Risk premiums widened further, wiping out the rally over the previous two weeks. The Xover was up 47bp to 485bp and the Main widened by 15bp. This left high yield credit 0.74% lower over the period while investment grade debt shed 0.98%.
In this discouraging environment, the new issues market for high yield remained shut.
In company news, Tullow Oil is to merge with Capricorn Energy to create a major player on Africa’s oil market with combined reserves of 1 billion barrels. Financial bonds were weaker after a two-week rally. Euro CoCo spreads were at 640bp, up from 625bp in the previous week and USD CoCos up 20bp to 448bp.
In CoCo and T2 new issuance, Aviva sold a sterling perpetual at 6,875%, Volksbank a euro perpetual at 7%, Vienna insurance a euro T2 at 4.875% due 2042, and BFCM a euro T2 at 3.875% due 2032.
We subscribed to the first two issues.
Elsewhere, Credit Suisse issued a profit warning that reactivated M&A rumours after years of underperforming other banks.
CONVERTIBLES
Despite troubled markets, there was one new issue. Redwood Trust, no stranger to the convertible market, raised $200m at 7.75% due June 2027. The company is a specialist in mortgage financing for homes.
In a thin week for news, the EDF saga provided some interest. After the failed Hercules project, the increase of capital and numerous profit warnings due to surging energy prices and government price caps, talk of nationalisation returned to the fore. The market seems increasingly convinced that the group will delist on the orders of the French state which owns 84% of the shares.
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
24/06/2022
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