2023 Weekly Views

Highlights

On rates

Investors have continued to revise higher their expectations for rate hikes. For the Fed, markets see a peak at 5.45% in July consistent with an upper range at 5.5%. For the ECB the peak is seen at 4% in Q3. In both cases, markets expect policy rates to remain there for the rest of 2023. This has led to a sharp increase in 2-year sovereign bond yields, up 14bps to 4.92% in the US, and up 18bps to 2.75% for Germany. Movements on 10-year yields have been similar, hence no change in the ten-to-two-year yield curve slope over the week. The increase in yields has been stronger in Europe than in the US as euro inflation surprised to the upside. This means that the 10-year Italian sovereign bond yield is now again well above 4% (a key threshold for Italy’s debt sustainability). But for now, 10-year Italian spread against the Bund remains below 200bps showing no significant worries from investors at a time when the ECB is about to launch its quantitative tightening.

Market update

Eventful weeks ahead

The S&P 500 closed the week at 4,045.64, +1.90% higher. The Dow Jones closed at 33,390.97, +1.75%, with the Nasdaq higher by +2.58%. The volatility index VIX closed the week at 18.49 down from 21.67. The Euro Stoxx 600 surged +1.43%.

The 10-year UST closed at 3.96% up from 3.94% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -90bps. US Corporate Bond spreads: Investment Grade widened 2bps at 195bps and High Yield tightened 12bps at 455bps. German 10-year Bunds yield closed at +2.72% up from +2.54% a week before. In Europe, Corporate Investment Grade spreads widened 2bps at 165bps and High Yield spreads tightened 6bps at 457bps.

The US Dollar Index (DXY) depreciated -0.66% last week and closed at 104.52. The Euro closed at 1.0635 (+0.82% weekly); the Yen appreciated +0.45%, closing at 135.87 and the Swiss Franc appreciated +0.45%, closing at 0.9362. Gold closed at $1,856.48 appreciating +2.51%. Oil was mixed, Brent closed at $85.83 (+3.21%) and WTI at $79.68 (+4.40%).

Macroeconomy

US economic data

The US ISM services index came in above expectations at 55.1 (vs 54.5 expected). The subcomponents were very strong, with new orders up to 62.6 (vs. 60.4 in Jan.), its highest level since Nov. 2021. The employment component hit its highest level since Dec. 2021 at 54.0 (vs. 50.0 in Jan.), and the prices paid component was down to a two-year low of 65.6. ISM manufacturing new orders rebounded to 47.0 after falling to a two-year low in Jan., but together with headline they remain in contractionary territory and suggest ongoing sluggishness in the goods sector. Prices paid rose above 50 for the first time in six months. Other indicators of supply chain stress (backlog of orders and supplier deliveries) have stopped improving. Unit labor costs, which account for productivity growth, were revised significantly higher. Y-o-y growth in Q4 was revised higher to 6.3% from 4.5%. Wages are growing fast and remain at levels inconsistent with the Fed’s 2% target.

Fed speakers

Minneapolis Fed Kashkari said that “I’m open-minded…about whether it’s 25 or 50 basis points”, and that the more important question was the signal in the dot plot, rather than the size of the next hike. Atlanta Fed Bostic said that “I think we will need to raise the federal funds rate to between 5-5.25% and leave it there until well into 2024”. He made the more hawkish comment that “history teaches that if we ease up on inflation before it is thoroughly subdued, it can flare anew. That happened with disastrous results in the 1970s”. Christopher Waller, a Fed governor, said that “recent data suggest that consumer spending isn’t slowing that much, that the labor market continues to run unsustainably hot, and that inflation is not coming down as fast as I had thought”. Mary Daly, San Francisco Fed, said that “In order to put this episode of high inflation behind us, further policy tightening, maintained for a longer time, will probably be necessary” and that “restoring price stability is our mandate and it is what the American people expect”.

European inflation

Eurostat's flash estimate showed that euro area headline inflation eased slightly to 8.5% y-o-y in Feb. from 8.6% in Jan., while core inflation accelerated to 5.6% y-o-y from 5.3% in Jan. (vs. consensus of 5.3%). Underlying price pressures remain strong and add to the evidence that disinflation will not be a linear process. The Feb. data will keep the ECB in hawkish mode at coming policy meetings. Investors expect a 50bps hike in March and another 50bps one in May, bringing the deposit rate up to 3.50%, with further 25bps hikes in June and July. Country wise, Feb. HICP inflation in France was a strong 7.2% y-o-y, +0.2pp vs Jan. Food prices continued to rise at 1.4% m-o-m. Energy inflation was strong as hikes in regulated electricity tariffs more than offset the decline in auto fuel prices. In Spain, Feb. HICP inflation came in at 1.0% m-o-m and 6.1% y-o-y, +0.2pp vs Jan. Electricity and food prices were the main drivers. Finally in Germany, HICP inflation was a robust 9.3% y-o-y in Feb., +0.1pp vs Jan., while it eased in Italy to 9.9% y-o-y in Feb. from 10.7%.

China economy

China’s official PMIs in Feb. surprised significantly on the upside. The manufacturing PMI rose further to 52.6 in Feb. (vs consensus of 50.6), while the non-manufacturing PMI continued to stay at an elevated level of 56.3. The improvement is broad based, with the improved sentiment in small enterprises particularly encouraging, as it registered the first expansion in almost two years. On services, sentiment in the construction sector also strengthened notably on the back of supportive macro policies and a likely acceleration in work resumption rate. At the National People Congress, government announced their 2023 economic targets: growth target is “around 5%”; on the fiscal front, fiscal deficit target at 3.0% of GDP (3.88 trillion yuan), and the quota for special local government bond is 3.8 trillion yuan; on the monetary policy front, inflation target unchanged at “around 3%”, and M2 and TSF (total social financing) growth will be in line with nominal GDP growth.

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.)