Weekly Market Update

Source: Bloomberg

As the year end closes in and the ‘Santa rally’ fades, investors were in a jittery mood last week, while a more pragmatic approach to Covid lockdowns in China offered a little cheer. Once again it was the back-and-forth economic data and the recession vs. no recession debate that set the tone. This was reflected in the rollercoaster ride for bond investors, with US 10yr Treasuries hitting 3.6% on Monday on strong ISM Services data that followed the better-than-expected jobs reports from the previous week, before rising fears of recession took yields to 3.4% mid week. It had all changed again by Friday with yields back at 3.6%. In the midst of this move, the 2s10s Treasury curve inverted even more, to a 40-year record, as investors increasingly price in recession ahead. This was also reflected in equity markets as cyclical sectors came under pressure and tech names were shunned. The Nasdaq Index fell 4% on the week, while the S&P 500 was off 3.4%. China was one of the few bright spots with the CSI 300 rallying more than 3% on signs that the Chinese authorities have heeded the message of frustration from the population and eased lockdown measures. Last week lent support to our cautious stance on risk assets versus bonds, and it was telling that the S&P has faltered at resistance levels. Despite the late rally in bond yields of Friday, signs are emerging of a disconnect between bonds and stocks as recession fears rise and safe havens are sought. 

China: Chinese equities soar on relaxed Covid-policy measures    

In a significant U-turn, China’s government  eased Covid-related restrictions in a 10-point plan that seems to prepare the path towards reopening. Excessive expansion of lockdown measures to whole residential districts in case of a single infection case will be banned, while cross-regional mobility will be eased. Schools without Covid clusters are to maintain normal teaching activities. Meanwhile, authorities must speed up booster vaccinations among the elderly to prevent a surge in mortality as experienced in Hong Kong. China’s ‘H’-shares surged 7.3%, while domestic ‘A’-shares gained 3.3% in an overall lacklustre Asian market environment. Moving to economic statistics, we note that exports and imports plunged more than consensus had expected in November, both in Mainland China and Taiwan. A broad variety of product categories were affected, with Western Christmas related demand plummeting. China’s exports to the US fell more than 25% YoY, for example. 

US: Service activity is holding up

Other than the recently published Services PMI, the ISM Services survey showed a pickup in service activity in November. New orders on the other hand fell to the weakest since June, pointing to a slowdown in the coming months. Interestingly, new export orders have collapsed over the past two months to the third weakest on record, having fared worse only during the pandemic and the financial crisis in 2008. Meanwhile, initial jobless claims only ticked up slightly to 230’000 but continuing claims have risen from 1.4mn in September to 1.7mn at the end of November. This pattern is in line with our view that firms are still reluctant to let people go but are becoming more cautious with regard to new hires, making it more difficult for jobless people to re-enter the labour market. Finally, producer prices slowed markedly but somewhat less than expected to an annual rate of 7.4% in November from 8.1% in October. Core PPI slowed from 6.8% YoY to 6.2% YoY. 

Eurozone: Retail sales fall but the ECB is preparing further rate increases and QT 

We are starting to get the first hard data for  Q4 in the Eurozone, and it is presenting a mixed picture. Eurozone retail sales fell -1.8% MoM (-2.7% YoY) in October, with declines broad-based across categories and countries. Retail sales volumes have been on a gradually declining path over the past few months, due to the squeeze on households’ real spending power because of record high inflation. Separately, industrial production in Germany was flat in October at -0.1% MoM (0.0% YoY) as falls in manufacturing output in the energy-intensive sectors were offset by gains in construction. Overall, the data so far support our view that recession started in Q4 in the Eurozone, though the severity of the recession will depend in large part on the winter weather, which so far has been milder than usual. Meanwhile, the ECB is preparing to raise interest rates further this week and is also expected to announce the details of its plans to begin quantitative tightening (QT) in 2023, highlighting how monetary policy is unlikely to support the economy next year. 

LatAm: Mixed surprises in the November inflation figures 

In Chile, inflation surprised to the upside in  November. Headline inflation rose 1% MoM, accelerating from 12.8% to 13.3% YoY. Prices continued increasing widely, with food and transport prices being the main drivers, but also with challenging core inflation. The central bank kept the policy rate on hold at 11.25%, confirming the end of the tightening cycle. The statement signalled that the policy rate will remain at the current level until inflation expectations converge to the inflation target. In Brazil, headline and core inflation reached 0.4% and 0.3% MoM, below market expectations, mainly explained by larger-than-expected Black Friday discounts. The central bank kept the Selic rate at 13.75% for the third consecutive meeting. The statement was more dovish than expected, with only a soft warning about the upward risk for inflation linked to an increase in fiscal spending. Therefore, we maintain our view that the easing cycle should start in H2 2023. Incoming President Lula nominated Fernando Haddad from the Workers Party as the next Finance Minister.  

Credit: Corporate bonds outperform bonds and stocks 

Corporate bonds have been outperforming  other assets since last month and last week was no different when spreads tightened while both stock and government bond prices fell. European Investment Grade credit notably outperformed over the last four weeks, as was to be expected given that valuations had nearly cheapened to those seen during the depth of the Covid crisis. However, even the relatively less alluring US Investment Grade and High Yield markets saw spreads decline in recent weeks as bond yields fell and supply slowed down.  Indeed, primary credit markets seem to be entering the year end lull earlier than usual. Flows seem to have tentatively stabilised, but a turn is required for a sustainable rally. On a separate note, European banks continued to prepay TLTRO loans, this time by around another EUR 450bn following EUR 300bn in November leading to a record reduction in the ECB’s balance sheet. This week is critical for investor sentiment as many major central banks meet and will set the tone for coming months.