Inflation puts central banks under pressure

• The prospects of more aggressive tightening sent bond yields higher
• Wage tensions in Europe are also relatively low compared to the US jobs market
• Amid reduced liquidity but upbeat company results, we remain neutral on equities

Central banks are split between acting to reduce inflationary pressure or waiting for the more transitory aspects of inflation to fall back unaided. In the first case, they risk jeopardising growth. In the second, low income families could see their purchasing power decline. 

US inflation accelerated from 7% in December to 7.5% YoY in January. FOMC member James Bullard immediately called for monetary normalisation to accelerate. He argued for an initial 50bp hike and 100bp by July. He also suggested balance sheet shrinkage should consist of selling bond holdings rather than just waiting for them to mature. The prospects of more aggressive tightening sent bond yields higher, especially short maturities. Yields on 2-year Treasuries rose to 1.6%. At end December they were at 0.7%.

As for the ECB, Christine Lagarde’s hawkish shift the previous week caused peripheral country spreads to widen and pushed the euro higher. But last week, there were a number of calls to moderate market expectations of any over-rapid normalisation. Raising rates too quickly would be counterproductive because it would undermine growth without causing inflation to fall; half of inflation comes from energy prices and the ECB has no control over them. Wage tensions in Europe are also relatively low compared to the US jobs market. In any case, the ECB reiterated its schedule: any rate hike will necessarily follow the winding up of bond buying and that will most probably occur in the second half.

Meanwhile, gas and electricity prices fell back a little thanks to a flurry of diplomatic initiatives to dial down tensions between Russia and Ukraine. The beginning of the winter Olympics in China also helped.

Chinese economic data, including the fall in January’s Caixin services PMI from 53.1 to 51.4, reflected an ongoing slowdown in the economy. Beijing’s insistence on a zero-Covid approach has undermined confidence and hurt the economy. Monetary policy easing will only feed through to the economy after several quarters.

Amid reduced liquidity but upbeat company results, we remain neutral on equities. In fixed income, we are still underweight government bonds and investment grade and remain cautious on duration.

EUROPEAN EQUITIES

Equity indices ended the period slightly higher despite volatile trading and a glut of earnings reports. After the ECB's recent shift and the latest inflation figures, bond yields rose and spreads widened, especially in peripheral countries like Italy and Greece. Gas prices continued to edge lower after upbeat solar energy figures in several European countries and reduced Russo-Ukrainian tensions. But electricity prices surged after nuclear production in Europe was revised lower. Tourism and commodities had the best week due to possible easing in sanitary conditions and a strong rise in industrial demand for commodities. Property, however, fell sharply on worries benchmark rates would continue to trend higher. 

In quarterly earnings news, Aurubis (copper) reported an impressive 85% rise in profits thanks to the auto industry. Semiconductor maker AMS Osram also posted excellent results and seemed to indicate that chip shortages would remain throughout 2022. Oil companies like BP and Total posted record figures due to higher crude prices and production chain optimisation. But Enel’s figures missed expectations due to disappointing results in hydroelectric and wind power production. Shipping company Maersk reported its best ever profits thanks to soaring freight prices. In consumer discretionary, Pernod Ricard delivered very optimistic guidance for 2022. The group is banking on bars reopening and consumers continuing to trade up.

US EQUITIES

Indices ended the five trading sessions up to Thursday evening in positive territory despite a sharp reversal when January’s consumer inflation data came in at 7.5% YoY, or higher than the 7.3% estimated. The Nasdaq almost moved out of correction territory and was down 10.6% compared to its November 19 high.

Investor nerves were tested further when St Louis Fed chair James Bullard argued for interest rates to rise by 100bp by July with an initial 50bp move in March. He also said he was in favour of hikes between the scheduled FOMC dates in March, May and June if necessary. Two other Fed officials, Loretta Mester (Cleveland) and Raphael Bostic (Atlanta), said that all options concerning the size of rate hikes in March were on the table and that they favoured shrinking the Fed’s balance sheet soon. 

Republican senators, and Democrat Joe Manchin, then stepped in to lambast the inflationary impact of stimulus packages and the damage done to household purchasing power. In these circumstances, the chances of Joe Biden’s Build Back Better programme being adopted are now even lower.

In company news, Meta lost more than 5% to hit a 12-month low after suggesting that its Facebook and Instagram applications would no longer be available in Europe if it was banned from storing European user data in the US. Peter Thiel, co-founder of PayPal and a prominent tech investor, is to leave Meta/Facebook’s board of directors after 20 years to focus on his political career and his support for Donald Trump. 

Premium exercise bike maker Peloton gained more than 20% on rumours that not only Amazon but also Nike and Apple were interested in a bid. Peloton gained another 25% the day after on news of a big cost-cutting plan that would lay off 20% of its workforce. 
Disney jumped more than 10% after the bell on Thursday when its results blew past expectations. Its Disney + streaming platform added 11.8 million subscribers, or much more than the 8.17 million expected, and its theme parks enjoyed a strong rebound.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX gained 0.51% and 1.12% over the period. After a tepid start due to US market weakness after strong jobs data fuelled concerns over inflation, Tokyo rallied on upbeat earnings. At the same time, inflation fears abated in the US. 
Cyclical sectors such as Iron & Steel and Glass & Ceramics rose 6.04% and 3.54%. Banks also gained ground on expectations higher interest rates would drive earnings. However, Mining, Warehousing and Precision Instruments declined. 

Shimano Inc. jumped 16.37% after operating profits soared 79.3% YoY instead of declining as expected by the market. Fourth-quarter sales hit a record high on strong trading in bicycle parts and fishing gear. On the other hand, recovery stock Olympus slumped 13.29% after operating profits for its third quarter (October–December) came in at JPY 32.7bn, or much less than the 40bn expected.

In Covid news, the government announced that priority prevention measures in 13 prefectures including Tokyo would be extended to March 6. Kochi prefecture will be added to the list. As of February 9, cases amounted to 889,049, an increase of 21,214 from the previous day.

EMERGING MARKET

The MSCI EM index rebounded by 2.63% as of Thursday’s close, with all major markets ending in positive territory. China was up 2.53% during the first trading week after Chinese New Year (CNY). India also gained 1.23% on domestic investor buying. Brazil (+2.99%) continued to rally and outperformed other regions.

In China, new RMB loans in January were higher than expected. Policymakers called for front-loaded efforts to boost project investment and stabilise economic growth. Beijing relaxed the proprietary pre-sale funds for housing projects, easing funding pressure for some developers. The PBoC sent more easing signals in the property sector and said bank loans to fund affordable rental housing would no longer be subject to regulatory curbs. Travel during the Chinese New Year was down slightly from last year and still 26% below pre-pandemic levels in 2019. In Hainan, 7-day sales in duty free shops during the CNY raked in nearly RMB 2bn, +144% YoY. The People's Daily published an article saying China should not rush to rein in carbon emissions but work on effective and clean use of coal. SoftBank stated that it was not involved in Alibaba's recent registration of an additional ADR. Wuxi Bio expects more than a 98% increase in net income in CY21, or above consensus. However, the company was added to the US DoC’s Unverified List this week, along with 32 other Chinese firms.

In Taiwan, Mediatek’s results and guidance beat expectations, driven by increased 5G adoption and high end expansion.

In Korea, four financial affiliates of the Samsung Group plan to launch a consolidated fintech application called 'Monimo' in March. This could hit KakaoPay’s market share. LG Chem’s quarterly results missed expectations due to the semiconductor shortage but order backlog remained solid.

In India, the RBI kept rates unchanged and maintained its accommodative stance. It also set forecasts for FY23 of GDP up 7.8% with 4.5% in consumer price inflation. Foreign institutional investors continued to take profits in January but domestic inflows supported the market. Bharti Airtel delivered solid quarterly results, beating expectations on rising ARPUs. Zomato reported lower-than-expected growth but narrowing losses for the third quarter of FY 2022 due to higher average order value and lower discounts.
In Brazil, January IPCA came in at 1.4% (versus 0.6% expected), a rise of 10.4% YoY, or higher than the 9.1% expected. Services in December rose 1.4% (vs. 0.6% expected). Bradesco reported weaker results due to higher expenses and provisions. Guidance was short of expectations because of lower client margins.

In Chile, consumer prices rose 1.2% from December to January (vs. 0.7% one year earlier), or well above the market consensus of 0.5%. The increase was mainly due to transportation and food prices. In Latin America, Chile is the most advanced country in terms of vaccinations and the reopening of economies.

CORPORATE DEBT

It was yet another choppy week in the US where the latest inflation figures pushed the yield on 10-year Treasuries over 2% for the first time since mid-2019. The trend was less pronounced in the eurozone but yields on the 5-year German Bund moved into positive territory and those on the 10-year Bund gained 6bp to 0.25%. Credit premiums naturally suffered, adding 5bp to 120bp on investment grade debt. They have now risen 20bp since the beginning of January. Premiums on high yield debt flirted with 380bp, +15bp over the period and +60bp year to date. In derivatives, the iTraxx Xover reflected investor nerves by trading between 290 and 320bp over the week, an 80bp increase since the end of December.

CREDIT

It was another good week for new issuance, both for IG and HY companies. Germany’s Infineon (semiconductors) raised €400m, and in high yield, Italy’s Cerved Group (credit/ESG ratings) €700m. In earnings news, Unibail Rodamco Westfield (commercial property) posted strong figures thanks to economies reopening. The group’s asset disposals programme in the US and Europe is also going well. Tereos (sugar) also had a good fourth quarter thanks to price momentum in soft commodities. However, Philippe de Raynal is stepping down as executive board chairman only one year after taking up the position.

In telecoms, France’s Iliad, accompanied by Apax Partners, bid more than €11bn for Vodafone’s Italian business but was turned down. Iliad, which is owned by Xavier Niel, moved into Italian mobiles in 2018 and currently has 10.5% of the market. The deal would have increased this to more than 33%. Italy’s legacy operator Tim is under pressure by rivals with aggressive pricing policies.

Elsewhere, regulatory authority opposition forced SoftBank to abandon plans to sell ARM to Nvidia. The $40bn deal would have meant $8bn in capital gains for the Japanese investment group. Softbank is now looking at listing ARM in early 2023 in an effort to monetise its stake.

Spreads widened with CoCos (contingent convertible bonds) giving up close to 50bp. US dollar denominated CoCos, however, held up well as Asian buyers returned to the market after the Chinese New Year. In earnings news, the trend was generally upbeat with a number of share buyback announcements from banks. Only Credit Suisse posted disappointing figures.

Following its annual review of capital requirements for Europe's banks, the ECB decided to increase them by 20bp on average for this year. Most of the rise related to NPL provisioning measures coming into force. As expected, the ECB decided against extending its exceptional easing of leverage ratio calculations beyond March 31 and its acceptance of non-compliance with some capital and liquidity requirements beyond December 31. 

CONVERTIBLES

Amid a cascade of earnings reports, Snapchat raised $1.3bn at 0.125% due 2028. 
TotalEnergies returned to profit last year thanks to oil price rises. The group made $16bn after losing $7.2bn in 2020. A $2bn share buyback programme is scheduled for the first half of this year. In contrast to Meta’s recent debacle, Twitter provided markets with a good surprise, releasing encouraging guidance and higher advertising revenues while announcing a $4bn share buyback programme. 

Back in Europe, meal delivery company Delivery Hero once again disappointed the market with more losses and growth that missed expectations. Home deliveries were a strong investment theme during the pandemic, but the outlook is now less promising and investors are increasingly turning away from the sector. France’s power giant EDF hit more turbulence after revising down output due to corrosion problems in the security systems of 5 nuclear reactors. The group also announced the acquisition of GE Steam Power (previously Alstom Power), the company which makes the Arabelle turbines for a third of power stations in the world, including EDF’s own EPR plants.

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

11/02/2022
This document is issued by the Edmond de Rothschild Group. It is not legally binding and is intended solely for information purposes.
This document may not be communicated to persons located in jurisdictions in which it would be considered as a recommendation, an offer of products or services or a solicitation, and in which case its communication could be in breach of applicable laws and regulations. This document has not been reviewed or approved by a regulator of any jurisdiction.
The figures, comments, opinions and/or analyses contained herein reflect the sentiment of the Edmond de Rothschild Group with respect to market trends based on its expertise, economic analyses and the information in its possession at the date on which this document was drawn up and may change at any time without notice. They may no longer be accurate or relevant at the time of reading, owing notably to the publication date of the document or to changes on the market.
This document is intended solely to provide general and introductory information to the readers, and notably should not be used as a basis for any decision to buy, sell or hold an investment. Under no circumstances may the Edmond de Rothschild Group be held liable for any decision to invest, divest or hold an investment taken on the basis of these comments and analyses. 
The Edmond de Rothschild Group therefore recommends that investors obtain the various regulatory descriptions of each financial product before investing, to analyse the risks involved and form their own opinion independently of the Edmond de Rothschild Group. Investors are advised to seek independent advice from specialist advisors before concluding any transactions based on the information contained in this document, notably in order to ensure the suitability of the investment with their financial and tax situation.
Past performance and volatility are not a reliable indicator of future performance and volatility and may vary over time, and may be independently affected by exchange rate fluctuations.
Source of the information: unless otherwise stated, the sources used in the present document are those of the Edmond de Rothschild Group. This document and its content may not be reproduced or used in whole or in part without the permission of the Edmond de Rothschild Group.

Copyright © Edmond de Rothschild Group – All rights reserved