The Fed sticks to its policy trajectory

• Following on from the ECB in the previous week, the Fed and the Bank of England raised benchmark rates by 25bp as expected
• China’s stock market bounced back from a big sell-off
• We are sticking with our equity underweight

Talks between Moscow and Kiev were in focus over the week but they failed to secure a ceasefire despite Ukraine’s president giving up his ambitions to join NATO. Instead, the conflict intensified and the EU adopted a fourth wave of sanctions banning the export of European luxury goods to Russia as well as steel and iron imports from Russia. Energy investments in Russia were also vetoed but not actual energy imports. The Council of Europe expelled the Russian Federation from the European Human Rights Convention, a move that will bar 145 million people from access to the European Court of Human Rights. Escalating sanctions are clearly a threat to growth but hopes for a rapid end to the conflict and Covid lockdowns in China resulted in commodity prices falling back. Oil and gas prices both retreated to around $100.

Following on from the ECB in the previous week, the Fed and the Bank of England raised benchmark rates by 25bp as expected. Both banks expressed worries over the impact of the war in Ukraine and the risk to growth. They are also concerned economies will be hit harder by commodity price inflation and supply chain tensions.

Today’s uncertain environment continued to push the safe haven Swiss franc higher. Switzerland’s central bank had previously stayed on the sidelines but confirmed that it had intervened in the previous week to get the franc lower.

China’s stock market bounced back from a big sell-off after Beijing promised to do everything possible to help the property market and ensure its target of 5.5% in GDP growth this year would be reached.

The crisis will have a very negative impact on global growth and even more so in Europe, so we are sticking with our equity underweight. We also remain underweight government and investment grade bonds and are cautious on duration as inflation is set to persist.

EUROPEAN EQUITIES 

Markets ended the period firmly in positive territory on rumours of a possible ceasefire in Ukraine. President Zelensky reiterated last Tuesday that he had abandoned hopes to join NATO. Moscow had previously insisted on this as a condition for starting talks. 

Despite this progress, the issue of what to do with the separatists in Ukraine still has to be resolved and Kiev seems less keen to make concessions on this point. Nevertheless, the mood helped cyclicals and the most battered sectors outperform. Financials, tourism and autos led gains after a month of underperforming. Oil stocks, however, were more or less stable over the period.

Companies remained focused on the fallout from the war. Germany’s RWE reminded investors that it depended on Russian gas. Despite upbeat full year results, management was naturally very cautious on the risks from the conflict in Ukraine. 

In luxury goods, Italy's Prada maintained its growth targets despite the war. The company had a good start to 2022. Last year, sales returned to pre-pandemic levels as upmarket brands played catch up. H&M’s preliminary results showed sales soaring in the first quarter as shoppers returned after the Covid crisis. Fraport (airline services) sounded a particularly cautious note on air traffic this year. The group operates Frankfurt’s airport and expects traffic to be running at 55-65% of 2019 levels with a return to pre-pandemic levels not before 2026. ADP, in contrast, is more optimistic and is banking on reaching 70-80% of 2019 traffic this year. Volkswagen warned that the impact of the war on production chains and commodity prices would impact its 2022 results.

US EQUITIES

US indices bounced over the last 5 trading sessions to Thursday with the Dow up 3.94% and the S&P500 3.57% better. The Nasdaq ended the period 3.69% higher. This left the Nasdaq 16% off its November highs so it has technically exited bear market territory (20% or more down).

Markets rose on hopes of an improvement in the Ukrainian conflict and Jerome Powell’s post-FOMC comments. As expected, the Fed raised rates by 25bp and Jerome Powell said there would be 6 more hikes this year. However, he reassured markets by claiming the US economy was strong enough to cope.

And yet data released at the beginning of the week suggested a more cautious approach might have been valid: producer prices in February rose 0.8% MoM, or less than the  0.9% expected. Ex food energy and services, they only rose 0.2% (vs. +0.6% expected). And New York's Empire State index for March tumbled 11.8 when it was seen rising 6.4%. The index was up 3.1% in the previous month. 

On the plus side, markets were boosted by falling jobless rates and better industrial production and housing start data. 

But the war in Ukraine continued and talks seemed to be getting bogged down. At least Russia promised to pay interest due on two credit lines in US dollars, a move that has reduced default risk for the time being.

In company news, we started to see the fallout from factory closures in China after a resurgence in the epidemic. Foxconn stopped production on its Shenzhen sites, including an iPhone factory, after the government ordered a lockdown. 

TV ratings company Nielsen jumped 31% on news that a consortium including Elliott Management was in talks to buy the company. Affirm plunged 15% despite management raising guidance for the third quarter and the full year. Third quarter revenues are now expected to come in above $335m compared to $325m/335m previously. Nikola was reportedly mulling an increase of capital that would create 200 million shares (or 48% of the current amount) with the proceeds earmarked for investments in electric car production.

Moderna, Pfizer and BioNTech gained ground on rising Covid cases in China and talks in various countries to recommend a 4th dose before the end of the year. 

Amazon rose 3.9% after getting the EU’s green light for its acquisition of the MGM studios.

Intel is to invest €33bn in a new R&D centre and semiconductor production in Europe.
Tesla advanced 4.6% after raising electric vehicle prices for the second time in a week to offset rising commodity prices.

Airlines saw buying after Delta Airlines and United Airlines raised guidance on expectations for a sharp recovery in leisure and business travel as the economy reopens.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX rebounded by 3.75% and 3.77% as geopolitical and economic uncertainties receded. Hopes rose for a ceasefire in Ukraine and the FED laid out its 2022 rate schedule. Sentiment was also underpinned on expectations Beijing would introduce stimulus to counter increasing Covid-19 cases.

Air Transportation jumped 10.54%. Insurance, Banks and Securities & Commodities gained 7.14%, 6.30% and 5.64%, respectively. Financials were supported by the FED’s rate hike. On the downside, Mining, Nonferrous Metals and Oil & Coal Products declined by 1.45%, 0.33% and 0.33%.

ANA Holdings rose 8.84% on falling Covid-19 infections and the possible revival of the “Go to Travel” campaign. Nissan Motor advanced 7.99% on yen weakness. Unicharm gained 7.96% on expectations it could benefit from trading in China. On the other hand, Sumitomo Metal Mining dropped 6.26% as resources came under pressure. Japan Tobacco declined 2.57% due to its Russian exposure. 

In Covid news, the Prior Prevention Measure will be lifted and the economy will reopen on March 21 across the country. The BoJ said that Japanese households held JPY 2,023 trillion in financial assets as of the fourth quarter of 2021, a 4.5% increase over 12 months. Cash holdings rose 3.3% over the same period due to Covid restrictions.
The BoJ monetary policy meeting was on March 17/18 with inflation and US rate hikes in focus. The bank is expected to maintain its current stance.

EMERGING MARKETS

The MSCI EM Index rebounded 3.3% as of Thursday’s close. China (+5.3%) led the way after the Vice Premier pledged to support markets. India continued to rally and gained 4.5% in USD. Brazil (+0.8%) also ended in positive territory.

In China, Vice Premier Liu He responded to key market concerns on the macro policy stance, property risks, the ADR audit dispute, and platform company regulation. February credit growth softened more than expected despite easing measures: Total Social Financing growth slowed by 0.3ppt to 10.2% YoY. This weakness echoed property markets and soft domestic demand. Premier Li pledged to support growth through tax relief and measures to keep real estate prices and markets stable. Xi Jinping will talk to Joe Biden about China’s relationship with Russia amid the Ukraine war. China’s foreign ministry endorsed remarks made by its envoy to Ukraine, in which Beijing delivered some of its most supportive comments yet. Saudi Arabia is considering accepting renminbi instead of dollars for Chinese oil sales. Shenzhen will allow factories and public transport in five districts to resume operations as Xi pledged to reduce the economic impact of its dynamic Covid Zero strategy. AIA announced its first buyback plan since its IPO, a $10bn programme over 3 years. Ping An 2021 results were broadly in line with company-compiled consensus, with steady growth in operating profit. Li Ning reported strong 2021 results, beating expectations on both the top and bottom line. The company is confident it can continue to gain market share and enjoy healthy sales/profit growth in the mid-term.

In India, February’s CPI inflation rose to an 8-month high of 6.1% YoY, or higher than the 6% expected. India agreed to purchase 3 million barrels of Russian oil at a heavy discount. The IPO of Life Insurance Corporation of India (LIC), the country’s largest listing, was postponed because of market conditions. The RBI lifted the ban on HDFC Bank's new digital launches. PayTM Payments Bank was banned by the RBI from onboarding new customers. Jubilant Foodworks corrected after announcing the departure of its CEO.

In Brazil, the central bank increased interest rates by 100bp as expected and added hawkish comments. Lojas Renner reported impressive top line growth of 22% YoY and SSS of 19%, driven by lower mobility restrictions and pent-up demand. Digital demand increased 38% YoY. Even so, margins remained under pressure because of rising inflation and higher commodity prices.

In Chile, President Boric will not support new pension fund withdrawals (after about $50bn, or nearly 16% of GDP, exited funds during the pandemic). Pension reforms will seek greater public involvement but no nationalisations.

In Colombia, the presidential primary elections and congressional votes unsurprisingly resulted in a strong showing for the left-wing front-runner Senator Gustavo Petro and his party coalition. Nevertheless, congress will remain highly fragmented and that could mean radical reforms being blocked.

CORPORATE DEBT

CREDIT

Investors seemed to be concentrating on possible advances in Russo-Ukrainian talks rather than China’s new Covid scare and inflationary tensions. Risk premiums fell sharply, with the Xover down 52bp and the Main tightening by 11bp. Interest rates rose as the Fed raised rates for the first time since 2018. Yields on the 10-year Bund rose 14bp and 19bp on 10-year Treasuries. Duration assets like investment grade fell (-0.11%) while high yield managed to rise 0.5% thanks to narrowing spreads.

High-yield issuers continued to post upbeat figures. Italian construction group Webuild (ex-Salini) saw 2021 sales bounce 40% to €6.7bn with Ebitda soaring 95% to €451Mn.
Elsewhere, Czech lottery operator Allwyn (ex Sazka Group) won the tender to run the UK lottery for 10 years starting in 2024. The National Lottery is the biggest in the world with £45bn in sales last year.

In subordinated financial debt, CoCo bonds performed well thanks to yield-hunting Asian buyers. Euro CoCo premiums tightened by close to 50bp over the period to 570bp, a level which is still higher than the historic mean. 

Meanwhile, the new issues market reopened with a T2 issue from Deutsche Bank. 
Banks continued to communicate on their Russian exposure. Some like UniCredit and Raiffeisen are now exploring ways to exit the country. As expected, Greek banks ended the earnings season with improved balance sheets.

In emerging country debt, premiums on the JP EMBI retreated by 50bp to 400bp, leaving prices 1.8% higher on the week. Note that Ukraine’s government bonds enjoyed a partial rebound, up 10% over the period.

CONVERTIBLES

The new issues market remained shut despite a brighter mood on markets. But it was a busy week for news on convertible issuers. France’s EDF launched its €3.1bn increase of capital. The move will reinforce its balance sheet amid soaring electricity prices and corrosion problems in its nuclear power stations in France. The group now expects a profit shortfall of €22bn, up from €19bn as previously indicated.

Elsewhere, Deutsche Post posted upbeat figures thanks to strong e-commerce growth and a recovery in its BtoB activity as economies reopened. Free cash flow in 2021 was €4.1bn and EBIT €8bn. The dividend will be increased by 33% and there will be a €2bn share buyback programme.

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
18/03/2022
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