2022 Weekly Views

Highlights

On rates

The market is now pricing a 50bps hike at the December Fed meeting, and the expectation for the ‘terminal rate’ has moved down to 4.90% according to fed funds futures (vs. slightly above 5.0% a few days ago). The US 10-year Treasury yield fell sharply to 3.84% over the week on the back of the US CPI print. The rally was driven mostly by lower inflation-linked yields, with the 10-year TIPS yield falling to 1.4% as market participants are revising down their Fed’s terminal rate expectations to below 5%. The rally was also beneficial to UK and German 10-year government bond yields, which fell in tandem, but less than their US counterpart. Of note, the 10-to-three-month US Treasury yield curve has inverted sharply over the week, falling into negative territory to -35 bps, as market participants see the end of the Fed’s hiking cycle approaching. US and euro credit spreads rallied at the end of the week. Nevertheless, the difference in spreads between CCC- and BBB-rated corporate bonds remain above 1000 bps signaling stressed market conditions. October default rate for US high-yield bonds picked up to 1.18%, driven mostly by higher defaults in utilities, healthcare and media.

Market update

Euphoria

The S&P 500 closed the week at 3,992.93, +5.90% higher. The Dow Jones closed at 33,747.86, +4.15%, with the Nasdaq higher by +8.10%. The volatility index VIX closed the week at 22.52 down from 24.55. The Euro Stoxx 600 rallied +3.66%.

The 10-year UST closed at 3.81% down from 4.16% a week before. The yield curve inverted with the yield spread between the 3-month and 10-year UST at -37bps. US Corporate Bond spreads: Investment Grade widened 3bps at 206bps and High Yield widened 22bps at 517bps. German 10-year Bunds yield closed at +2.16% down from +2.30% a week before. In Europe, Corporate Investment Grade spreads tightened 8bps at 223bps and High Yield spreads widened 3bps at 634bps.

The US Dollar Index (DXY) depreciated -4.14% last week and closed at 106.29. The Euro closed at 1.0347 (+3.92% weekly); the Yen appreciated +5.33%, closing at 138.81 and the Swiss Franc appreciated +5.37%, closing at 0.9417. Gold closed at $1,771.24 appreciating +5.31%. Oil was down, Brent closed at $95.99 (-2.62%) and WTI at $88.96 (-3.94%).

Macroeconomy

US inflation

October US CPI inflation was lower than anticipated. Headline inflation was 0.4% m-o-m (vs. 0.6% expected), pushing down the y-o-y reading to 7.7% (from 8.2% in Sept.). Core CPI inflation was 0.3% m-o-m vs. 0.5% expected and the y-o-y print eased to 6.3% (from 6.6%). There was a decline in used car prices (-2.4% m-o-m) and in apparel (-0.7% m-o-m) reflecting the continued easing in global industrial bottlenecks. There was also unusual help from medical services, which are very volatile (-0.6% m-o-m, from +1.0% m-o-m in Sept.). Rents slowed modestly but remained firm overall at +0.7% m-o-m (vs. +0.8% mom in Sept.), or 7.5% y-o-y. Rents are likely to remain firm for the next 3-6 months, before dropping sharply by mid-2023 (private-sector data is already showing a sharp slowdown in rents).

Fed speakers

Some Fed officials spoke after the CPI print, but they sounded cautious not to extrapolate too much from just one CPI print: Dallas Fed’s Logan said that the softer CPI data was “welcome relief” but there was still “long way to go” to tackle inflation. Philadelphia Fed’s Harker said the Fed could be on hold at some point “next year”. Over the weekend, Federal Reserve Governor Christopher Waller said, “these rates are going to stay and they’re going to stay high for a while until we see this inflation get down closer to our target”. “We’ve still got a ways to go. This isn’t ending in the next meeting or two”.

Chinese economic data

October Chinese headline inflation of October came in at 2.1%, down from 2.8% in Sept. and below expectations. Core inflation remained unchanged at 0.6%. While rising pork prices could drive headline inflation higher going forward, the weak domestic demand could continue to weigh on core inflation through lower housing rental and services prices. Inflation will unlikely become a constraint to the PBoC (China Central Bank) in terms of monetary policy support. October Chinese PPI came in at -1.3%, reflecting both the correction in commodity prices and weakening demand. The strong correlation between Chinese PPI and Chinese export prices (with the former leading the latter by roughly three months) implies that the price pressure from Chinese exports to the rest of the world could start to reduce soon.

China Covid & Real Estate

Chinese leadership had a high-level meeting on Thursday regarding covid policy. While the leadership continued to stick to the zero-covid policy, it called for an acceleration of the vaccination campaign. In addition, it required the government to better balance between covid control and economic activities. The meeting was followed by a series of changes in covid-related measures on Friday, which include a reduction in quarantine time for inbound travelers, preparing the health system for a potential rise in infection cases and moderation in covid-related restrictions and so on. Over the weekend, the PBoC and the CBIRC (China Banking and Insurance Regulatory Commission) jointly issued a set of new measures to support the property sector. These are the strongest and clearest policy support to the sector since the property crisis started, including: financial institutions should treat property developers under state or private ownership equally when issuing development loans; ensure “continuous and stable” fundraising by construction companies; developers’ outstanding bank loans and trust borrowings due within the next six months can be extended for a year; bond issuance by quality developers will be supported. Repayment on developers’ bonds can also be extended or swapped through negotiations; policy banks should offer special loans “in an efficient and orderly manner” to ensure property projects are delivered. These measures could significantly improve the financing situation of some developers.

What to watch

• Monday: US ISM manuf. index (Apr.)
• Tuesday: Australia RBA decision (May); Euro area: final PMIs, M3 (Mar.), Bank Lending Survey (Q1), flash HICP (Apr.); US durable goods (Mar.)
• Wednesday: US FOMC decision (May); US ISM non-manufacturing index (Apr.)
• Thursday: Norway Norges Bank decision (May); Euro area ECB decision (May); US trade balance (Mar.)
• Friday: Germany factory orders (Mar.); US: nonfarm payrolls (Apr.)