- Inflation expectations rose and 10-year real interest rates in the US moved above 1% for the first time since December 2018, slamming growth and tech stocks
- The European Commission showed its determination to decouple gas and electricity prices with a plan to carry out an energy market reform
- We remain prudent on equities and are still close to neutral on duration
Trends among major asset classes suddenly reversed last Tuesday after US inflation accelerated, particularly in underlying areas like services and rents.
Inflation expectations rose and 10-year real interest rates in the US moved above 1% for the first time since December 2018, slamming growth and tech stocks. US 10-year Treasury yields also rose to around 3.4%. Credit markets followed suit with the iTraxx-Crossover index breaking above 500bp. The euro fell back to parity with the US dollar in a few seconds.
Even so, the US economy is still robust. The New York Fed’s manufacturing index was better than expected thanks to new orders rebounding into expansionary territory. True, industrial production was slightly down in August, due mainly to energy, but it remained at historically elevated levels. The NFIB survey also showed that small companies were doing well and in optimistic mood, another favourable indication that the Fed might be able to ensure a soft landing.
In Europe, Germany unveiled fresh support measures to help deal with the energy crisis. Households will see their electricity bills capped and there will be a €67bn loan guarantee fund to help struggling companies.
France's finance ministry is now expecting inflation to stay higher for longer, pencilling in 4.2% in 2023 compared to 3.2% previously. Prime minister Elisabeth Borne said the cap on electricity and gas prices would be extended to 2023 with price rises limited to 15%.
The European Commission, meanwhile, showed its determination to decouple gas and electricity prices with a plan to carry out an energy market reform. It also proposed a windfall tax on power companies which could raise €140bn.
The negative outlook for growth was boosted by the World Bank’s warning of a global recession next year. The bank cited the removal of post-pandemic stimulus and monetary tightening in most parts of the world. Europe is the most at risk due to its high exposure to the energy crisis.
Caution will remain the watchword in the coming months even if governments and central banks are seeking to engineer a soft landing. We remain prudent on equities and are still close to neutral on duration.
EUROPEAN EQUITIES
European markets tanked after a brief rise following some easing in energy prices. Poor inflation figures in the US triggered the sell-off as well as fears of a bigger recession due to gas shortages over the coming winter. Germany once again revised its growth forecasts lower as the economy tried to adjust to possible energy shortages. Gas consumption, for example, was down 22% compared to usual seasonal levels. Chancellor Olaf Scholz said a price cap on electricity bills would be introduced shortly to protect households. Note that Germany's CPI slowed slightly in August.
The European Commission announced a series of measures to deal with the crisis. The commission wants to reform the energy market to decouple gas and electricity prices and introduce a windfall tax on power companies which it hopes will bring in €140bn. Utilities could well bear the brunt of this tax as Europe only represents a small percentage of revenues for oil companies. Despite this tricky situation, the UK’s labour market remained stretched with only 3.6% unemployment. Unfilled positions are still coasting along at an historically high level and wages accelerated by 5.4% in July (excluding bonuses).
In company news, Lufthansa said that prices would not go back to 2019 levels immediately as they would be unsustainable for a sector facing various crises. After lengthy talks with its unions, Air France raised its wages by 5% and introduced a €1,000 inflation premium. TotalEnergies will soon have to deal with wage demands. Its unions called for a strike in favour of higher pay and increased investment in renewable energy. In the tech sector, France’s OVHcloud is getting ready to face any energy outages over the winter. The company said it would be ready to use electricity generators running on diesel fuel if necessary. On a more positive note, Roche Bobois reported excellent figures after its high-end products proved resilient to inflationary pressure.
US EQUITIES
Wall Street suffered its biggest daily rout since June 2020 after the consumer price index came in higher-than-expected. The S&P500 tumbled 4.3% and the Nasdaq plunged by 5.2%. Although petrol prices sank 10.6% in August, the CPI still rose 0.1% MoM when it was seen falling by the same amount. The more worrying aspect was the 0.6% rise in core CPI, more than twice expectations.
Fed Funds futures are now 100% betting on a 75bp hike at the next FOMC on September 20-21 with a 33% probability that the Fed will opt for a full percentage point. A further 75bp rise in November followed by 50bp in December cannot be ruled out. That would take rates to 4.5% instead of the 4% previously expected.
Elsewhere, retail sales rose 0.3% MoM in an indication that US consumers are still spending despite the low-growth environment. Manufacturing indices like the Empire State and Philly Fed were less positive and reflected a gradual slowdown.
In results news, Oracle gained 2.8% on better-than-expected figures boosted by a 43% YoY surge in cloud activities. The picture was more mixed with other reports: Fedex sold off after guiding on slower business in the months ahead and software company Adobe made a big acquisition while warning on a slowdown in growth.
Banks warned on a slump in investment banking business. Goldman Sachs is to lay off hundreds of people after its M&A activity plunged by 41% in the second quarter. Citigroup’s finance director Mark Mason said on Thursday that the bank expected a 50% drop in investment banking in the current quarter.
Apple gained 3.8% on news that pre-orders for its iPhone 14Pro Max were running ahead of expectations, forcing the company to extend delivery times from 5 to 7 weeks. In pharma, Bristol Myers gained 3.1% after the FDA approved its psoriasis drug Sotyku.
After spending $1bn on Disney’s shares, the activist Third Point fund abandoned its demand for the group to spin off its ESPN sports channel.
In social network news, stiff competition from TikTok is proving tough for Meta’s apps according to a Wall St Journal report which says users are spending less time watching Reels than TikTok. In contrast, Pinterest’s user numbers are on a rising trend. Twitter gained 0.8% after its extraordinary shareholders’ meeting approved Elon Musk’s bid despite Musk's attempt to withdraw it.
In a strong indication of risk aversion, Bitcoin fell 10%, its biggest drop since June.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX slipped by 0.67% and 0.37% over the period due to a higher-than-expected consumer price index in the US and the possibility of further rate hikes. However, sentiment was boosted by the fact that Japan is about to end border controls, including the limit on foreign arrivals, and set to waive visa requirements in October.
Air Transportation and Land Transportation rose 5.43% and 4.74% on hopes for a boost to tourism. Other Manufacturing gained 3.54%. Elsewhere, Rubber Products, Fishery Agriculture & Forestry and Precision Instruments dropped 2.66%, 2.52% and 2.33%.
Investors bought into travel stocks. East Japan Railway, West Japan Railway and ANA Holdings jumped 8.26%, 7.06% and 5.47%, respectively. In contrast, Shimano fell 4.30% on concerns over an economic slowdown from more tightening in the US. Kansai Electric Power fell 3.69%. The market worried about deteriorating earnings after other power companies announced dividend cuts.
The yen traded between 141-145 to the dollar during the period. The Bank of Japan conducted a currency rate check on 14 September. The Forex market is expecting currency intervention after policymakers stepped up warnings about sharp falls in the yen. The yen strengthened to 142 after the rate check.
EMERGING MARKETS
The MSCI EM Index retreated by 2.0% as of Thursday’s close. Brazil and China markets were down by 4.9% and 2.6% in USD term, respectively, underperformed other region. While India continued to outperform other regions, lower by 1.0%.
In China, August economy prints came stronger than expected. Industrial production was up 4.2%, beating 3.8% estimated; Retail sales +5.4%, beating 3.3% forecasted; Fixed Asset Investment +5.8%, higher than consensus of 5.5%. Headline unemployment rate edged down to 5.3% from 5.4% and the widely-watched youth unemployment rate fell to 18.7% from 19.9%. Five of the largest SOE banks cut individual deposit rates to offset the pressure on NIM narrowing. The regulator approved 73 domestic online games for September, with one game by NetEase and one from Tencent subsidiary. Chengdu city is gradually lifting Covid lockdown starting September 15th. On the property side, Zhengzhou government signed a Rmb 300bn agreement with China Development Bank, of which 160bn used as shantytown renovation loans. Country Garden plans to issue as much as Rmb 1.5bn onshore bond, backed by state-owned credit support provider. The Biden administration signed an executive order laying out a strategy to bolster domestic biotech manufacturing and reduce reliance on China for new medicines, chemicals and other products. BMW announced agreement with CATL and EVE on supply of 4680 cylindrical battery cells for their Europe and China giga-factories with 20GWh annual capacity each.
Korean exports fell 17% yoy in the first 10 days of September while imports declined 11%. For the past five months through August, the country's trade balance remained in red.
In Taiwan, TSMC reported August sales a record high for the second straight month, up 17% mom and 59% yoy.
Indian CPI spiked to 7.0% in August, slightly above estimates of 6.9% and July reading of 6.7%. The rise in inflation was mostly driven by higher food prices. Separately, the factory output, IIP rose 2.4% yoy in July vs 4.2% estimated and 12.3% in June. Google is planning to shift the assembly of 10% to 20% of its Pixel smartphones from China to India. Vedanta announced a 19bn$ semiconductor project with Foxconn, with the project set to be undertaken at the holding company level.
Brazil's retail sales fell 0.8% in July from vs previous month and 5.2%, below expectations. Only fuels and lubricants posted growth in the month, mirroring a series of cuts in fuel prices by state-owned oil company Petrobras. Anfavea reported another strong recovery of car production and sales. August car production up 44% yoy and sales were up 21% yoy. Local newspaper, reported that Natura is planning to concentrate its operations in Latin American, abandoning its global platform (management has not confirmed this news yet).
In Mexico, Industrial activity rose by 2.6% yoy, driven by increases in output of vehicles & auto parts, machinery & equipment and refining. According to Citi’s CFO, BANAMEX Citibank could still consider an IPO of Banamex next year as an alternative to divest from its Mexican unit.
CORPORATE DEBT
CREDIT
Credit and interest rate spreads widened amid worries over growth and stubbornly high inflation. The Xover and Main widened by 20bp and 3bp to 545 and 110bp, respectively. Yields on the Schatz and the Bund rose by 30bp and 10bp.
Paprec’s second-quarter figures were bolstered by acquisitions but margins remained under pressure due to inflation. Management is now sounding more cautious for the coming quarters. Credit indicators stabilised: leverage was 3 times compared to 2.9 at end March 2022 and liquidity remained at a solid €753m.
S&P upgraded Banijay Group from B to B+, citing better credit metrics over the last 12-18 months as earnings rose and the group generated strong free cash flow.
The high yield new issues market reopened with Italy's Lottomatica raising €350m over 5 years at 9.75%, a single B-rated issue priced at a 200bp premium compared to outstanding bonds.
In financials, euro CoCo spreads widened by 4bp, essentially due to the impact on interest rates of the CPI reading in the US. Doubts on the health of Chinese conglomerate Fosun weighed on companies it holds stakes in, notably Portugal’s biggest insurance company Fidelidade. Fosun has an 85% stake. On a more positive note, Italian bank Ifis is offering to refinance one of its Tier 2 bond with an exchange into a new Tier 2 bond. This is another example of banks trying to satisfy investors by calling their Tier 2 bonds at the first call date. Despite wide spreads, the new issues market remained open to peripheral cooperative banks like Spain’s Cajamar and Italy’s Iccrea, both of which sold senior debt. Raiffeisen, the European bank which has been the hardest hit by the Russo-Ukraine conflict, also managed to place a Tier 2 issue at 7.375%.
CONVERTIBLES
Another week of nervous trading sent markets sharply lower. Even so, average convertible valuations were on the whole unchanged. And the new issues market was once again busy. In the US, furniture maker Wayfair raised $600m to refinance its 2024 and 2025 issues. In healthcare, Alnylam and Sarepta raised $900m and $1bn with 2027 maturities to refinance borrowings. NextEra Energy raised $2bn in preferred 2025 notes to fund projects.
In Europe, Germany's SGL Carbon raised €100m at 5.75% due 2027 to refinance its 2023 convertible. France’s Elis raised €380m at 2.25% due 2029, also to refinance existing debt.
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
16/09/2022
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