Weekly Market Update

Source: Bloomberg

The tragedy of war in Europe has again become a reality as Russian forces invaded Ukraine last week. Despite the inevitable human cost, investors took a dispassionate view of events as is so often the case in times of war. The sharp correction in financial markets as the invasion commenced reversed course when the tanks rolled in and sanctions were announced, with US stocks actually closing up on the week. Oil prices breached USD 100 intraday for the first time since 2014, before moderating slightly. The implication from markets was that Russia’s expansion would be restricted to the Ukraine and have a limited impact on global corporate profitability and the economic cycle. While the surge in energy prices will undoubtedly dent growth if they are maintained for a protracted period, economic conditions are generally robust and are likely to absorb the headwind. The inflationary impact is more concerning, coming at a time when inflation is already significantly above target on a global scale and forcing central banks to accelerate tightening. However, the conflict is likely to inject a degree of caution into the process, which investors appreciate. To us, despite the depressing human toll that is being borne, the old investor adage of ‘sell the rumour and buy the news’ is likely to drive stocks and bond yields higher bar further escalation, though the process will be bumpy.

Credit: Sentiment remains fragile

Credit markets were volatile last week and are opening weak this morning as Russia’s invasion of Ukraine has dented investor sentiment. While some stability returned to credit on Friday, further developments over the weekend such as new sanctions from the West and the prospect of a prolonged conflict have the potential to increase uncertainty further. Despite the notable weakness in corporate bonds, credit derivative indices fared better. Europe led the weakness in cash credit markets, given it’s relatively higher exposure to the Russia-Ukraine conflict. European bank credit underperformed as European bank stocks dropped by over 8% on Thursday alone. In contrast, US high yield saw spreads tighten over the week, led by the energy sector amid the rising price of oil. While geopolitical risk impacts tend to fade, the broader headwinds for credit are likely to persist, unless central banks change their stance notably. Consequently, sentiment is likely to remain fragile in credit for some time. 

US: Strong growth and still surging inflation point the way for rates 

Despite the dreadful developments in Ukraine, any doubts about a Fed rate hike in March were surely put to rest as a string of strong economic readings and a further jump in inflation were reported last week. House prices rose 1.5% in December and are up 18.6% on a YoY basis, while personal spending rebounded by 2.1% in January. Durable goods orders also surprised positively with strong revisions to prior data, but it was the PMI readings that caught our attention. While the manufacturing reading moved back up to 57.5, a five-and-a-half-point improvement in services to 56.7 implies a strong reopening of the service sectors as we had hoped. With the US economy in rude health a further jump in the Fed’s favoured PCE inflation readings makes a March rate hike a near certainty. Headline PCE was 6.1% YoY, with the core at 5.2% ⎯ a long way from the Fed’s 2% target. 10yr Treasury yields briefly breached 2% despite the geopolitical turmoil, while stocks closed the holiday-shortened week modestly higher, despite massive intra-week volatility.

Eurozone: Business surveys point to a rebound, but geopolitics will weigh 

Various business surveys were released last  week, all carrying a similar message. The region’s service sector economy is bouncing back as the Omicron wave fades, while supply-side disruptions are easing in the manufacturing sector. For example, the flash Eurozone PMI survey jumped more than four points from 51.1 in January to 55.8 in February, while manufacturing confidence remained at a robust level and supplier delivery times improved. The German ifo Business Climate index also rebounded sharply in February, while the European Commission’s Economic Sentiment indicator increased more than two points, with a four-point gain in the services subcomponent. However, these surveys were released before the invasion of Ukraine, which has led to a spike in oil and gas prices. This will increase inflation further and dampen real spending power, but we do not think that the current jump in energy prices is enough to completely derail the recovery. 

Switzerland: GDP growth slows as expected, but the outlook remains favourable 

GDP growth slowed from 1.9% in Q3 to 0.3% QoQ in Q4. The moderation was expected, partly reflecting a normalisation in growth dynamics after the reopening bounce-back, and partly due to headwinds from rising infections and renewed restrictions. The underlying details were solid, with brisk manufacturing activity despite supply chain issues and gains in consumption and investment. Government spending also bolstered growth. Looking forward, we expect activity to hold up well in 2022, with strong external demand and a healthy domestic backdrop likely to provide resilience amid the challenging geopolitical situation. Households are benefiting from the strong labour market and favourable financial conditions, as reflected in the latest retails sales data, which showed a rebound in January following some moderation in Q4. The KOF leading indicator finally ticked down in February but remains well above the  historical average and is consistent with above-trend growth in the economy. 

Japan: Omicron is hitting Japan’s consumption and production 

We are not surprised that the retail sales and  industrial production statistics released today for January came in weaker than consensus had expected. We have flagged before that the surge in Omicron cases as well as supply chain issues and labour shortages in the manufacturing sector would negatively impact Japan’s economy in Q1. Retail sales contracted 1.9% MoM following a downward revised contraction of 1.2% in December. Considering that services consumption is likely to have been hit even more seriously than goods consumption, we suspect that overall private consumption will contract in Q1. Industrial production contracted 1.3% MoM versus -1% in December, with motor vehicle production showing a substantial drop of 17.2% MoM. Companies project a recovery in February and March, but these forecasts tend to be too optimistic. However, we expect a strong rebound in Q2 as new Omicron cases are already falling and labour shortages should have subsided by then.