The macroeconomic environment calls for caution

• The risk premium on French and European assets is unlikely to disappear, or climb significantly
• The ECB confirmed its intention to stop its asset purchases in the third quarter
• We are now more cautious over our equity exposure and remain underweight sovereign bonds

The order of arrival in the first round of France’s presidential election held no surprises. However, the gap between the top three and the others was much bigger than expected. As in 2017, the second round will be a contest between Marine Le Pen and Emmanuel Macron. The risk premium on French and European assets had risen ahead of the first round and is unlikely to disappear, or for that matter climb significantly. The euro rose after the result but then wiped out its gains. Yields on French government bonds fell back a little, reducing the spread with the German Bund.

Talks between Russia and Ukraine are at a standstill. But a major clash is brewing to control territory in south-east Ukraine where Moscow is hoping to win. Oil prices returned to $107 at the end of the period but had previously dipped below $100 as the sanitary situation in China deteriorated and European countries decided not to put an embargo on Russian oil for the moment. There was, however, an agreement to step up military aid to Ukraine.

In China, March consumer price inflation rose 1.5% vs. 0.9% in February, or more than expected, due to rapidly rising commodity and food prices. Producer price inflation slowed much less than expected to 8.3%, not only because of surging fuel and fertiliser prices but also because of state-imposed anti-pollution regulations and lockdowns in strategic regions like Shanghai.

US producer prices rose by a record 11.2% over 12 months in March and by 7% ex food, energy and transport. Consumer prices also accelerated to 1.2% MoM in March, a worrying signal for household purchasing power despite wage increases due to the buoyant labour market. Investors, however, focused on the reassuring drop in underlying inflation and Treasury yields dipped by 9bp for 2 and 10-year bonds.

30-year mortgage rates are now above 5.1% but there has so far been no collapse in demand for property loans.

The ECB said on Thursday it plans to reduce its asset purchases on the markets to 30 billion euros in May and 20 billion in June, from the current 40 billion. It confirmed its intention to stop its purchases in the third quarter and intends to start raising rates thereafter. It is still unclear to what extent the Fed will tighten further but we should tread carefully, especially as equity markets are unused to radical action to normalise liquidity. As a result, we are now more cautious over our equity exposure and remain underweight sovereign bonds.

EUROPEAN EQUITIES

Equity indices were generally flat over the week pending developments in Ukraine, the second round of France’s presidential elections and data on inflation. The week kicked off with a fresh surge in 10-year government bond yields. In Germany, they gained 11bp to 0.81%, their highest level since mid-2015, on persistent worries over inflation and the pace of central bank tightening. At the same time, an ECB survey of eurozone banks showed strong demand for loans in the first quarter, not only mortgages but also consumer lending. Meanwhile, the main economic bodies advising the German government slashed the country's growth forecasts for this year from 4.8% to 2.7% and warned of a possible recession if an embargo were to be put on Russian gas and oil. Debates over whether to ban Russian oil imports continued among EU countries and the chances of that happening increase every time Russian army exactions are exposed.
In company news, LVMH followed Hermès in posting excellent results. Like-for-like growth at Hermès was up 27%. Société Générale confirmed that it had managed to sell its Rosbank stake and expects to book a loss of around €3bn. In autos, Volkswagen expects semiconductor shortages to continue up to 2024. The group expects supply to return to 2019 levels by 2023 but thinks this will be insufficient to meet much stronger demand. The UK's food delivery service Deliveroo said demand was slowing as the sanitary situation returns to normal. The group also said it was worried about household purchasing power. Management said average order size had fallen by 6% in recent weeks while the group’s pricing power remained hindered by persistently strong competition.

US EQUITIES

The Dow managed to end the period higher but the other indices lost ground after US consumer price inflation came in at an annualised 8.5%, a 40-year high. The bond market's reaction was nevertheless muted with 10-year Treasury yields down 5bp to 2.75% as core CPI, ex food and energy, came in at 6.5% YoY, or slightly less than the 6.6% expected. The figures were taken as a sign that inflation had peaked.

In a flurry of comments from Fed officials. Charles Evans, normally a dove, said that speeding up rate hikes to combat inflation was a subject that needed to be discussed. In contrast, Christopher Walker, tried to reassure markets by saying the Fed would do everything possible to avoid collateral damage from rate hikes.

The first-quarter earnings season started and Factset expects a 5% increase in profits from S&P500 companies as a whole. This would be the smallest increase since the fourth quarter of 2020 (+3.8%) at the height of the Covid crisis.

JP Morgan’ results showed a sharp slowdown in the investment banking business and much higher provisioning because of the global slowdown and worsening geopolitical risk. Loan demand was still rising but not as fast as expected. The stock sold off on the news. Elsewhere, airline traffic moved back closer to normal even for business travel. Delta still posted a loss for the quarter but expects to make record operating margins over the summer.

In M&A, private equity firm Thoma Bravo bid $6.9bn, a 30% premium, for SailPoint, a company owned by our Big Data and Equity Opportunity funds.

Despite the ongoing lockdown in China, oil and commodity prices started rising again. Stocks in these sectors made strong gains over the week.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX dipped 0.17% and 0.15% over the period, weighed down by the Fed’s more hawkish stance, higher inflation from oil prices and the war in Ukraine. Concerns over rising Covid-19 cases in China also negatively affected Asian stock markets including Japan.

The Mining sector gained 5.47% on higher natural resource prices. Electric Power & Gas rose 4.47% on expectations nuclear power plants might be recommissioned after PM Kishida hinted at increased nuclear power use due to the Ukraine crisis. Fishery, Agriculture & Forestry rose 4.03% as investors turned defensive. In contrast, Securities & Commodities declined by 1.92% as investors turned risk-off. Retail Trade fell by 1.89% on worries consumption would be hit by rising food prices. Marine Transportation shed 1.69% as investors took profits on fears soaring crude prices and supply chain disruption from sanctions on Russia would lead to a global slowdown.

Chubu Electric Power and Kansai Electric Power jumped 8.05% and 5.37% on possible re-commissioning of nuclear power plants. Mitsubishi Heavy Industries rose 7.73% on higher military spending. On the other hand, Shionogi tumbled 12.66% after the health ministry panel announced that its Covid-19 pill did not meet the “presumed efficacy” standards under the proposed emergency approval system. Shimano fell 5.63% due to supply chain disruption. Sysmex Corp ended the period 5.04% lower on profit taking.
The Japanese yen fell to a 20-year low against the US dollar on Wednesday as yields on 10-year Treasuries moved as high as 2.8%. The yen traded above 126 against the dollar at one point, breaking through the 125.86 mark hit in June 2015 and falling to a low not seen since May 2002. BoJ Governor Kuroda’s comments on maintaining accommodative monetary policy also fuelled yen weakness.

Finance Minister Shunichi Suzuki said on Wednesday that sharp currency moves were “very problematic” and warned against excessive yen declines.

EMERGING MARKETS

The MSCI EM Index edged down 0.7% as of Wednesday’s close. China (-1.8% in USD) underperformed on ongoing concerns over the economic impact of the zero-covid lockdown. India (-1.4%) also underperformed. Brazil and Taiwan closed the first 3 days of the week flat.

China's CPI inflation rose to 1.5% YoY in March (vs. 0.9% in February), driven by increased fuel costs and a more gradual pace of deflation in food prices. PPI inflation eased to 8.3% YoY in March from 8.8% in February. March exports, in US dollar terms, grew 14.7% YoY, or above the 12.8% expected. Imports fell 0.1% YoY, vs. an expected 8.4% gain. In March, TSF, RMB loans and M2 growth accelerated materially and were all well above market expectations on the back of policy support.

Short term financing growth was still much faster than medium-to-long term loan growth, which continued to imply weak credit demand relative to credit supply.
China is accelerating the issuance of local government special bonds to further boost investment and stabilise growth amid mounting pressure due to the Omicron outbreak. In a sign of regulatory easing, the National Press and Publication Administration (NPPA) resumed video game licensing and approved 45 new titles after an 8-month freeze. 8 cities were selected for a trial of shorter COVID quarantines. Beijing is offering RMB 300m in green consumption coupons to stimulate purchases of energy-efficient home appliances. Expectations for imminent rate cuts before the weekend rose as the State Council hinted strongly that it would the RRR at the appropriate time.

Taiwan bought 700,000 units of Pfizer’s Paxlovid and quarantine requirements for inbound travellers are reportedly to be removed as early as this summer, according to the CDC. Apple suppliers Pegatron, Quanta and Compal suspended factory activities due to the Shanghai and Kunshan lockdown. TSMC reported better than expected first-quarter sales with a strong FY22 order status particularly in advanced nodes. The company also expects to improve gross margins for this quarter to 56%-58%.

In India, March CPI rose 6.95% YoY from 6.07% in February, or higher than the 6.4% estimated. The RBI left the repo rate unchanged. It has now been at an historic low of 4% for 11 consecutive quarters. The standing deposit facility (SDF) rate was set as the floor of the rate corridor, effectively raising short end rates. Joe Biden and Narendra Modi held a virtual meeting ahead of the scheduled annual 2+2 Ministerial meeting between the two countries. Despite differences on the Ukraine/Russia crisis, both countries reaffirmed their strong ties. Results at TCS for 4QFY22 beat expectations, while margin pressure continued as the attrition rate reached an all-time high. Infosys 4QFY22 results were below estimates and the company delivered growth guidance of 13-15% compared to the 17% expected by the consensus.

Brazil’s March inflation IPCA exceeded expectations, rising 1.62%, or the highest for March since 1994. Retail sales in February rose more than expected to 1.3% YoY, helped by the unwinding of pandemic restrictions and greater mobility as the Omicron wave fades.

Chile’s inflation surged more than expected to 1.9% in March, its highest level in almost 30 years.

CORPORATE DEBT

CREDIT

Pressure on government bond yields persisted. Yields on the 10-year German Bund gained 8bp while 10-year US Treasury yields dipped by 2bp. Credit spreads widened a little with the Xover up 7bp and the Main 2bp.

It was another week with no new issuance in the high yield segment but there was lots of news on issuers. The Atlantia saga continued to dominate the headlines. Edizione, the Benetton family's holding company and Atlantia's biggest shareholder, launched a bid on the infrastructure group with the support of US investment fund Blackstone. The bid values Atlantia at €54bn, a 24.4% premium to the last quoted price before the operation was announced. Elsewhere in M&A, Iliad (Free) is interested in bidding for Telecom Italia's services division according to Italian press reports. Iliad has been in Italy since 2018 and has already argued for tie-ups between companies in the country. The group failed last year with its €11.25bn bid for Vodafone's Italian subsidiary.

The first reports from the first quarter’s earnings season revealed upbeat results for highly cyclical companies. Portuguese airline TAP saw sales jump 27% compared to the same period in 2021 and also reinforced its balance sheet by adopting a restructuring plan.

Financial debt spreads widened further with euro CoCos ending the week 22bp wider. In banking news, Société Générale sold its Russian affiliate Rosbank but there will only be a relatively limited 20bp impact on its CET1.

CONVERTIBLES

Volatility ebbed but there were no new issues this week. However, the first quarter earnings season kicked off with investors looking for any impact from inflation on profitability. Among convertible bond issuers, LVMH was the first to report. Its results were once again upbeat. In spite of the sanitary crisis still sweeping China, its core market, the group reported like-for-like growth of 23% with €18bn in sales.

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

14/04/2022
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