Smoothing the path to monetary normalisation

• Central banks took note of a surge in inflation expectations
• The Fed started tapering, it will reduce asset purchases by $15bn a month up to June 2022
• The supply chain situation has improved and so have shipping costs. And oil prices are trying to stabilize

Central banks took note of a surge in inflation expectations in October but still sought to reassure markets that inflation was only temporary.

Australia's central bank officially abandoned its goal of trying to control 3-year interest rates but said it was being very patient over rising short term rates. The Fed, meanwhile, started tapering. It will reduce asset purchases by $15bn a month up to June 2022. Chairman Jerome Powell nevertheless said inflation was only a temporary Covid effect and that any talk of raising rates would have to wait until a return to full employment.

The Bank of England’s monetary policy committee caused the biggest surprise by voting 7 to 2 to leave rates unchanged. Markets had been betting on a rise in short term rates. Inflation expectations were still revised up to a peak 4.8% in 2022 but the bank sees them falling back to 2% by 2024. This should mean only a very gradual return to normal monetary policy. All this caused yield curves to steepen with short term rates falling more than long rates.

Wage and property price inflation is undeniable but the supply chain situation has improved and so have shipping costs. And oil prices are trying to stabilize despite the OPEC+ cartel refusal to increase output.

Equity markets pushed even higher amid this financial repression with rock bottom real rates and higher earnings also providing support. Rising production costs will probably hit future margins but there is no sign of that as yet.

Tokyo gained more than 3% over the week after the LDP held onto its majority in the Lower House. A new stimulus package is now in the pipelines.

We are still neutral on equities overall but with a preference for Japanese equities. In fixed income, we continue to focus on corporate debt and have been gradually raising duration because of higher rates. We remain underweight government bonds.

EUROPEAN EQUITIES

After a 22-year gap, the CAC 40 hit a record high. Other European indices also made gains. The trend was underpinned by encouraging earnings reports.

With bond yields falling after central bank comments, tech stocks outperformed. But consumer discretionary and industrial goods/services also did well as rosy results helped them shrug off market worries over logistics and shortages. Bank stocks, however, retreated as interest rates eased. Despite the OPEC+ cartel’s refusal to boost production, energy and commodities also slipped as prices fell back. Elsewhere, the WHO warned on rising Covid cases in Europe, a potential threat to a recovery in tourism and the economy as a whole. At the same time, interim group Adecco said labour shortages were hurting.

Airlines released encouraging results. Ryanair and Lufthansa returned to the black in the third quarter for the first time since the pandemic struck. Both companies are confident air traffic will gradually recover. Société Générale posted upbeat third-quarter results and its merger with the Credit du Nord network has made good progress. BMW managed to compensate for losses from semiconductor shortages and logistical disruption by raising prices and managing its product mix efficiently. Zalando, however, lost a little pricing power as shopping centre reopened. It reported excellent third-quarter figures but was forced to cut prices to stay competitive. Despite a drop in new European car registrations, Ferrari blew past expectations with its best FCF figure since 2015. Téléperformance’s upbeat results led the group to raise guidance again.

US EQUITIES

Over the last five trading sessions to Thursday, the Dow Jones gained 1.1% and the S&P500 1.82%. The Nasdaq surged 3.19%. The MSCI Global Index hit a record high on Thursday, its fourth in a row.

Unsurprisingly, the Fed left rates unchanged and said it would start tapering asset purchases to the tune of $15bn a month from mid-November. Jerome Powell said the Fed could be patient before hiking and that inflation was high but not set to last. Markets are now pricing in a first hike in July 2022, or just after tapering ends in June.

Macro data was mixed. Weekly jobless claims hit a post-Covid low but non-farm productivity contracted by 5% in the third quarter, the most since 1981! Labour costs jumped 8.3%, or more than the 7% expected. ADP data showed that US job creations had beaten expectations in October with the biggest move in 4 months.

Saudi Arabia and its OPEC+ allies refused to heed Joe Biden’s calls to increase output, leaving the US President to decide whether he would dip into strategic reserves to get prices down.

Companies continued to post generally robust figures but there were some unpleasant surprises. Education stocks sold off after Chegg warned on staff shortages and said the pandemic would have a bigger impact on enrolments than expected. Online education platforms suffered their worst-ever day last Tuesday when the sector plunged 49% to its lowest level since March 2020.

Elsewhere, Zillow saw the worst fall since March 2020 when it announced that it was abandoning its home-flipping division.

Online market place Etsy struggled to maintain momentum compared to very demanding 2020 comparisons but growth was still impressive. The stock jumped 13% despite more cautious guidance.

JAPANESE EQUITIES

Stocks tracked the US market higher with the NIKKEI 225 and TOPIX up 3.38% and 2.80%. Political uncertainty receded after the ruling Liberal Democratic Party (LDP) won the majority of seats in the Lower House election and the market started to focus on the new administration’s economic stimulus. Upbeat earnings also lifted sentiment.
Textiles & Apparel gained 6.05% on reopening hopes. Electronic Appliances and Precision Instruments gained 5.65% and 4.07%. In contrast, Securities & Commodities, Electric Power & Gas and Metal Products were down 2.44%, 0.41% and-0.12%, respectively.

Companies posting upbeat results were in focus. Z Holdings jumped 14.01%, revisiting its January 2006 high after net profits rose 18% YoY. Its CEO also announced positive news on operating costs. Fujifilm Holdings gained 8.95% thanks to strong trading in its healthcare businesses. Toray was up 8.51% thanks to its high-functional resin. On the other hand, Nomura Holdings tumbled 6.45% after earnings plunged 75% YoY and Chubu Electric Power shed 5.66%. Panasonic fell 5.56% on profit-taking after the previous week’s sharp gains.

The new administration is preparing a big economic stimulus package which will be decided in mid-November. Investment in clean energy is going to be a main point. And the “Go To Travel” programme, which was suspended due to a Covid-19 resurgence, may be relaunched to help revive tourism and service industries.

EMERGING MARKET

The MSCI Emerging Market index closed 0.31% higher as of Thursday’s close. China edged 0.39% lower while Brazil closed flat. India (+2.27%) outperformed.

In China, official manufacturing PMI fell for a second straight month in October to 49.2 while the NBS services PMI slowed down to 52.4 vs 53.2 in September. China unexpectedly boosted the injection of short-term cash to RMB 100 billion ($16 billion) Friday after boosting it to 50 billion earlier in the week. Cash-strapped property developers in China are accelerating asset sales: Kaisa, which delayed the payment of its wealth management product, reportedly plans to sell property projects valued at almost $13 billion to raise capital. Premier Li Keqiang said new policies are needed to offset the difficulties for market entities, particularly small firms, as the economy is facing new downward pressure. Yellen said reciprocal lowering of tariffs on US-China trade could help ease inflation. The Ministry of Commerce called on people to stock up with essential goods in preparation for winter months as a COVID resurgence is highly possible. Shanghai Disneyland Closed for 2 days, and 33,000 people were tested for COVID following a single positive case. In regulatory news, the SAMR released a draft on internet platform classification and defined responsibilities for each category. The regulator also issued enforcement guidelines against bad advertising practices in the plastic surgery and beauty industries. Tencent unveiled its first three Ai computing, video processing and high-performance network chips following the government's push to boost the domestic semiconductor industry.

Hong Kong expects to resume reopening with China at scale in February 2022 according to Chief Executive Carrie Lam’s public speech. In Taiwan, 3Q GDP rose 3.8% YoY (and 0.6% QoQ), or below the 4.3% expected. This marks a slowdown from last quarter’s 7.4% rise.

Korea’s inflation hit a near decade-high. CPI rose 3.2% YoY in October from 2.5% in September, or slightly below expectations. LG Chem shares fell on reports that a Jaguar car using an LG Chem battery had caught fire.

India lowered retail fuel taxes, resulting in a drop of around 8-9% for petrol prices and 15% for diesel prices. The prime minister said the country was aiming to reach net zero emissions by 2070. Dixon Technologies reported a strong quarter with 71% YoY revenue growth and delivered an upbeat outlook thanks to new opportunities emerging within existing and new segments. Varun Beverages reported a 32% rise in volumes for its domestic business as “on the go” consumption recovered; operating leverage helped the EBITDA margin expand by 100bp YoY despite higher commodity prices.

Vietnam proposed its largest-ever stimulus package, $35bn or 10% of 2020 GDP, to support companies, infrastructure investment and social support.

In Brazil, the congress narrowly approved the government’s bill for court payment orders (“PEC precatorios”). The bill still has to get Senate approval. The central bank released hawkish minutes after the last monetary policy committee, implying further interest rate increases (market consensus is for 150bp in December). Industrial production fell 0.4% in September. In company results, Itau reported net profit above consensus, driven by strong retail loan growth and a better net interest margin. Bradesco also reported a creditable 35% YoY rise in net results, or 6% better than expected, and also raised 2021 guidance. Mercado Libre saw revenues jump 66% jump (in $) and higher EBITDA margins, driven mainly by Argentine payroll tax benefits.

The OPEC+ cartel rejected calls from the US, Japan, and India to increase output and only agreed to maintain its current pace of supply increases.

CORPORATE DEBT

CREDIT
Reassuring words from US and European central banks helped interest rates ease. It was good news for credit spreads and the Main tightened by 2bp and the Xover by 14bp. As a result, investment grade credit returned 0.74% and high yield 0.26% between Monday and Thursday.

European companies continued to post robust quarterly figures. Sales at Casino came in at €7.7bn, or better than expected. Management confirmed EBITDA targets for the full year and said it would press on with its €4.5bn disposals programme. It has so far raised €3.1bn. S&P Global Ratings had previously upped Casino’s outlook from negative to stable while confirming its B rating.

Lufthansa's sales were an upbeat €5.21bn or double the figure over a year. The group also returned to operating profitability (€17m) thanks to its restructuring plan and an increase in reservations.

In oil services, losses at CGG narrowed sharply in the third quarter to $17m, down from $93m a year earlier. Sales also jumped 35% over a year to $270m as oil companies increased exploration capex.

In company news, shipping group CMA CGM said it had bought a container terminal operator at the Port of Los Angeles for €2bn. This is a strategic move as port bottlenecks have been creating shortages, and especially in the US.

Ford is planning to redeem $5bn in high yield bonds as part of its balance sheet restructuring. Its debt had risen sharply due to emergency Covid loans. The bonds pay interest of above 8.5% and will be redeemed using available cash with the possibility of a new green bond with a 10-year maturity.

In financials, Crédit Suisse posted CHF 434m in third-quarter earnings. The bank had been through a difficult time at the beginning of the year due to its investment bank division. It also said it would be refocusing on wealth management. It plans to reduce investment banking and drop its prime brokerage unit after huge losses from hedge funds exposed to Archegos and Greensill.

Net results at Germany’s Commerzbank came in at €4.3m, or much higher than expected, thanks to lower NPL provisioning and a reduction in costs.

Société Générale’s profits doubled over a year to €1.6bn in the third quarter. France’s third-largest bank also saw net banking income rise 14.9% to €6.67bn.

Standard & Poor’s downgraded La Banque Postale's subordinated financial debt following its decision to buy out minority shareholders in CNP Assurances.

CONVERTIBLES
The new issues market swung back into action despite the earnings season. In the US, Impinj Inc raised $250m at 1.125% with a May 2027 maturity. The company manufactures radio-frequency identification devices and software. The proceeds will go on refinancing its outstanding 2026 convertible.

The biggest convertible bond issuer news over the week was a merger rumour between Qiagen and Biomérieux. A tie-up would result in a biotech with a €25bn market cap. Qiagen had already attracted buying interest after activity bounced significantly due to Covid. Last year, Thermo Fisher Scientific made a $12bn bid.

Qiagen also reported a 10% rise in third-quarter sales to $535Mn along with a 30.8% margin ($164.6m). The group revised guidance higher and is now expecting sales to rise 15% for the full year.

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
05/11/2021
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