- The ECB raised rates by 50bp and now has more leeway over future monetary policy
- The preliminary eurozone PMI for July showed activity slowing
- We remain cautious on equities and have returned to neutral weightings on bonds
The ECB’s rate-setting committee surprised markets on Thursday by raising rates by 50bp, and not 25bp as announced in June. The move ends 8 years of financial repression and negative rates. But by abandoning forward guidance, the bank now has more leeway over future monetary policy, albeit at the cost of predictability. And its new Transmission Protection Instrument (TPI) reduces the risk of eurozone fragmentation.
10-year spreads between Italy and Germany remained high due to fresh political risk in Italy. Mario Draghi resigned after losing the support of part of his coalition. Italy’s president dissolved parliament and called for elections on September 25. A right-wing coalition, led by Giorgia Meloni’s Italian Brothers and including the Liga and Forza Italia, is currently credited with 45% of voting intentions in polls.
In the UK, the two remaining candidates to replace Boris Johnson are Liz Truss, the former Foreign Secretary and Rishi Sunak who was Chancellor of the Exchequer. The winner will face significant challenges as inflation accelerated to 9.4% in June over a year. The Bank of England sees it rising to 11% by the end of this year due to soaring gas prices and a tight labour market.
The preliminary eurozone PMI for July showed activity slowing, particularly in Germany where the services and manufacturing indices moved below 50. In the US, the property and labour markets appeared to be slowing after overheating in recent months, a necessary evil if inflation is to be curbed.
Gas deliveries via the Nord Stream 1 pipeline resumed after maintenance interrupted them for 10 days. However, they could be stopped again by the end of the month due to a delay in the delivery of a turbine from Canada, and the pretext that a second turbine is needed. The European Commission urged member states to embrace energy sobriety by cutting consumption by 15%. Inventories need to be built up before winter if dependence on Russian energy is to end.
We remain cautious on equities and have returned to neutral weightings on bonds. Given the economic slowdown, sovereign debt offers interesting yields and also enhances portfolio diversification. Corporate debt is also trading at attractive valuations.
EUROPEAN EQUITIES
Indices rebounded, thanks mainly to the Nord Stream 1 pipeline resuming deliveries. The ECB ended up surprising markets by raising rates by 50bp rather than 25bp. The decision was taken only one day after Mario Draghi resigned as Italy's prime minister. His departure followed a refusal by three of his coalition parties in the Senate to support him. The week also saw the first quarterly results from European companies. The picture was mixed even if the scope of companies reporting was limited. The figures showed up the first difficulties facing some companies but there was also resilience in some sectors.
In home deliveries, Deliveroo drastically revised down sales guidance for 2022, citing increased headwinds for consumption. UK consumer confidence is at a low due to reduced purchasing power. In e-Commerce, shares in Made.com plummeted as demand fell more than expected. The online furniture company sees sales falling 15-30% this year as UK households slash spending on non-essential goods. In contrast, semiconductors remained buoyant judging from better-than-expected results from ASML with its healthy order book. Even so, the company said that some of its customers were beginning to see the first signs of a slackening in demand. At the same time, Nokia’s CEO, announcing upbeat results, said he could see some improvement in semiconductor shortages. In the Luxury sector, first-half sales at Armani jumped 20% to above pre-pandemic levels. Nevertheless, the group said its business could suffer if China reintroduced sweeping sanitary restrictions or if there were to be a serious recession.
US EQUITIES
The Dow gained 4.59%, the S&P500 5.5% and the Nasdaq 7.19%, mainly because of signs of a modest slowing in activity. Weekly jobless claims came in at 251,000 or above the 2140,000 expected, retail sales rose 1% in June (+0.9% estimated), manufacturing in the New York region jumped 11.1% (-2%) and household confidence was 51.1 (50). Inflation expectations over a year came in at +5.2% vs. +5.3% previously, and +2.8% over 5-10 years vs. +3.1% last month.
All in all, the figures suggested that a 100bp hike at the July 26-27 FOMC was unlikely and that a 75bp move would probably be the last in the current tightening cycle.
Treasury Secretary Janet Yellen reassured investors that US jobs and consumption were healthy. Upbeat earnings announcements also underpinned the trend.
However, sentiment was dented by the record plunge (excluding Covid) in the NAHB confidence indicator. It fell from 67 last month to 55.
With the earning season in motion, Refinitiv estimates that analysts now expect a 5.9% YoY increase for S&P500 companies. This is a big contrast with the beginning of April when they were expected to fall 6.8%.
Banks provided encouraging pointers. Bank of America said it saw no signs of a slowdown among its client base. Results were also better than expected at Citigroup and Wells Fargo. JP Morgan, in contrast, adopted a more cautious approach by increasing NPL provisioning.
Elsewhere, Pinterest jumped 16% on Friday after the Wall Street Journal said Elliott Management had taken a stake of more than 9% in the social media service.
Tesla gained ground after an earnings beat and comments from management that production in the second half would hit record levels. CEO Elon Musk said he expected supply chains to return to normal soon and commodity prices to fall back.
Amid a stabilisation in its user base, Netflix reassured investors on its FCF and spending.
Some companies adopted a more cautious tone. Apple intends to slow down hiring and investments because of the economic slowdown. IBM fell 4% after the bell on Thursday when the company reduced FCF guidance for the full year. ASML cut its sales guidance for 2022 by 10-20% due to supply side constraints. Social media company Snap plunged 27% in after-hours trading on Thursday due to disappointing quarterly figures. Advertising revenues fell sharply while competition with Meta/Facebook and Alphabet/Google intensified.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX rose 4.35% and 3.04% over the period -the Nikkei225 gained on 6 consecutive days- as fears of a US downturn receded and US tech stocks posted better-than-expected figures. Sentiment in Tokyo was also boosted by the BoJ sticking to accommodative monetary policy and expectations of upbeat results.
Marine Transportation rose 6.33% as major shipping companies revised up their FY’23 profit guidance due to much higher-than-expected demand and continuing supply chain disruption. Electric Appliances and Machinery gained 5.35% and 5.26% on positive economic data and healthy US company results. The weaker yen also helped. Elsewhere, Electric Power & Gas and Fishery Agriculture & Forestry slid 0.90% and 0.04% on profit taking in defensive sectors due to risk-on sentiment. Insurance dipped 0.21% as US interest rates seemed to be peaking.
Fast Retailing jumped 14.10% after revising up guidance on earnings and its dividend payout. Sysmex Corp, a diagnostic instruments maker, and Shimano, a bicycle parts maker, gained 8.53% and 8.06% on recovery hopes. On the other hand, Shionogi fell 2.47% as the health ministry panel once again delayed approval for Xocova, its COVID-19 experimental pill. Kansai Electric Power fell 1.97% on profit taking. Sompo Holdings also declined 1.90% on profit taking.
The yen strengthened to 137.36 against the US dollar, up from 138.96, as US bond yields stopped rising.
Japan's new COVID-19 infections topped 186,000 on Thursday, a record high, with Tokyo, Osaka and many other prefectures reporting increases spurred by the highly transmissible BA.5 omicron sub-variant. Tokyo's new cases hit 31,878, topping 30,000 for the first time. The previous record in the capital was 21,562 on February 2.
At a news conference on Wednesday, Chief Cabinet Secretary Hirokazu Matsuno reaffirmed that movement restrictions would not be introduced despite a surge in cases across the country.
EMERGING MARKETS
The MSCI EM Index rebounded 3% during the week as of Thursday’s close. India (+3.63%) outperformed. China gained 1.58% but underperformed following recent contagion fears over mortgage boycotts. Brazil closed almost flat in USD as commodities retreated.
China’s GDP rose 0.4% YoY in the second quarter, or less than the 1.2% expected. June CPI rose to 2.5% on higher energy and pork prices, up from 2.1% in May. PPI growth eased, rising 6.1% YoY in June, the slowest rate in 15 months. Industrial production rose 3.9%, up from 0.3% in May. Retail sales also recovered, up 3.1% in June driven by auto sales. Total Social Financing (TSF) rose above consensus and credit mix also improved on recovering credit demand from corporates and households. The trade surplus hit a record after Shanghai reopened and exports surged 18%, sweeping past forecasts. Around 300 property project homebuyers threaten to stop paying for mortgages on off-plan properties due to construction delays while CBIRC redoubled efforts to ensure developers complete projects. Didi was fined $1.2bn for violating cybersecurity and data laws. 67 games were approved in the 3rd batch of video game licensing, including 2 for Bilibili. NetEase is planning to debut the Diablo Immortal mobile game in China on July 25th. Wuxi Biologics released a positive profit alert with both topline and bottom line beating market expectations; the company also unveiled a 10-year investment plan to expand in Singapore. Kweichow Moutai’s preliminary net profits rose 20% as expected on a 17% increase in revenue. Anta (sportswear) announced better-than-expected second quarter retail sales, mainly helped by a solid recovery in June with 618 online promotions and a partial recovery in offline traffic.
Macau is set to reopen casinos and public services from this Saturday after one week of lockdown.
The Bank of Korea raised its benchmark interest rate by 50bp to 2.25% to fight inflation. SK Hynix is reportedly considering cutting its 2023 capital expenditure by a quarter on weaker demand.
Taiwan's exports rose 15.2% YoY in June, the second highest monthly total on record, on the back of strong technology demand, especially for chips, with supply chain problems easing. TSMC announced another strong quarter and raised full year guidance on solid Cloud, AI and auto demand despite an industry downturn.
In India, June CPI rose 7.01% YoY driven by high energy prices. This was largely unchanged from the previous month and slightly below expectations. The RBI has allowed trade settlements between India and other countries in rupees. The government cut its windfall tax on exports and crude oil production. Adani Group announced its participation in 5G spectrum auctions, raising fears of a new entrant in the mobile telecom space. TCS and HCL Tech released their 1QFY23 results with top line growth in line with estimates on healthy demand, while the EBIT margin continued to contract on higher subcontracting and travel costs. Hindustan Unilever’s quarterly results beat estimates on stronger volumes and successful cost control. HDFC Bank reported a strong pick up in core PPOP growth to 15% YoY despite a sharp 29% increase in Opex.
Indonesia’s June trade surplus is expected to widen after palm oil exports resume. Exports surged more than 40% YoY in June.
The Philippine’s central bank hiked interest rates by 75bp in an unscheduled meeting.
Thailand's government is seeking to boost its economy by allowing foreigners to fully own land for residential use.
Brazil registered a record high tax collection in June. WEG results were in line with expectations while operating margins were under pressure on supply chain uncertainties.
Chile’s peso rallied following central bank intervention.
South Africa’s central bank surprisingly raised its repo rate by 75bp to 5.5%, or the biggest hike in two decades.
CORPORATE DEBT
CREDIT
In a busy week for news, geopolitical tensions eased after Russia announced the Nord Stream 1 pipeline was reopening after maintenance. There is now less pressure from a possible blackout in Europe next winter. And for the first time since 2011, the ECB raised its rates, this time by 50bp. Short rates then surged, with the yield on Germany's 5-year bonds up 18bp over the period. Credit risk premiums eased, with the Xover down 70bp and the Main 15bp lower. This left the high yield index 1.76% better. Investment grade only managed to return 0.15% due to rising rates.
There was again no issuance over the week. With the earnings season now in motion, investors watched for any impact from inflation on results.
Materials and construction have been badly hit. Consolis (ready-made concrete) saw its EBITDA margins plunge due to rising costs and despite a 21% jump in second-quarter sales. It was a different tune among cyclicals. Germany's Lufthansa returned to the black in the second quarter and slashed leverage. Sales rose to €8.5bn. Thanks to a recovery in tourism and strong cargo activity, the group estimates its EBIT over the quarter at €400m, the first positive score since the pandemic ended.
It was the same story at travel retail specialist Dufry, which could be in for a credit upgrade. S&P has put the group on “credit watch positive” as its merger plans with Italy's Autogrill could mean easier credit conditions in the coming financial year.
In financial debt, there was a significant rebound over the week despite political instability in Italy and threats of another tax on banks in Spain. Euro CoCo spreads tightened by 46bp following the return of gas through the Nord Stream 1 pipeline.
Newsflow remained generally upbeat. Greece’s banks and Spain’s Cajamar were put on positive outlook at S&P. And the first quarterly figures to emerge were encouraging, especially on interest margins as asset quality stayed intact.
CONVERTIBLES
Indices rose in line with credit and equity performance. The new issues market stayed shut but the earnings season provided interest.
Results were varied. Snapchat was indicated sharply lower after racking up a $422m loss in the second quarter. In contrast, Ubisoft's figures were in line thanks to its popular flagship games Rainbow Six and Assassin’s Creed.
On the M&A rumour mill, Akamai (content delivery and cloud) was mentioned as a possible bid target from a private equity fund. The EDF delisting advanced, with the government fixing the exit price at €12 for minorities, some of whom do not agree with the price.
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
22/07/2022
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