Good news is good news (this time)

A lower than expected US October Consumer Price Index propelled all asset classes higher last week

AT A GLANCE

A lower than expected US October Consumer Price Index propelled all asset classes higher last week
Hopes for “peak inflation” obviously encourage less aggressive action from the Fed and its Western peers
It’s good news, but the downshift in inflation is not large enough to see a radical shift in monetary policy yet.

Sensational week after sensational week, markets confirm two things: first, monetary policy is the single most important driver, dwarfing everything else. Second, markets are not ready for good news. With a lower than expected October US CPI released last week, all asset classes had a spectacular rebound. Weekly returns were around +6% for stocks across regions, while all segments of fixed income were in the green, from 2% for high yield and EM debt to more than 4% for DM government bonds. The US 10-year Treasury yield dropped from almost 4.2% to 3.8% in a week, and even gold was up +5%. Good news indeed.

No doubt, the inflation reading was positive, especially ex food and energy – core inflation. Core good prices had their largest monthly decline since March, which also confirms that the supply shocks are fading – they were the starting point of the current inflation episode. Having said that, core US inflation is still very high at +6.3% year-on-year. It’s a step in the right direction, but it’s way too small to allow central banks to declare mission-accomplished. We are confident in the downward trajectory of good prices, even more so as news from China today seem to indicate more pro-growth measures ahead. However, the services sector remains crucial when it comes to risks of wage/price spiral. In any cases, the impact of tighter financial conditions on the economy has only begun: growth has been resilient so far but higher rates will take their toll.

We didn’t change our positioning during our TAA committee: we are close to neutral on stocks and favor govies within fixed income. Markets are proving that they are not ready for good news, but excessive confidence is also dangerous. Volatility should remain extreme, we stay relatively neutral, and patient.

Cross-asset Update

A Russian oil price cap might be more difficult to enforce than the West thinks. It should become effective from the beginning of December, provided that President Putin is willing to provide supplies at the capped price, that the United States and its allies must have given for granted. Lower energy prices would of course be more than welcome in Europe, where shortages and inflation must have pushed the area into recession as per the latest business surveys. But the Kremlin might disappoint expectations, even if exporting at lower prices is devised in such a way as to be still profitable. Russia is exporting to Asia, so the West must take this into account, not having unbounded leeway in setting a price. So far, having Russia buckle under the weight of a countless number of restrictions has proven more difficult than originally expected. Sanctions have inflicted quite some economic pain to the NATO countries themselves, in particular hard-to-bear inflationary pressures, while soaring energy bills have required bail outs of some utility companies, unable to sustain the costs of sourcing energy at skyrocketing prices. On the other hand, despite a heavy discount for Russian crude and fewer shipments, Russia’s oil exports were $15.3bn in September, as per Bloomberg, higher than its monthly average revenue in 2021.

President Putin said that shutting Russian oil from exports to the West would be doing more damage to Europe and North America than to Russia, a point on which analysts seem to agree. Should tensions escalate further, the Kremlin might opt to definitely cease those exports, rather than accept the caps. Washington suggested that insurance is withheld from buyers of Russian oil above an agreed price, but Moscow could find ways to circumvent the system by setting up alternatives and ultimately deliver to Asian clients. The proxy war between the two blocks seems set to continue, with huge costs in both camps.

If the Fed is not going to tighten above 5%, a huge if, gold could have found a bottom and longer dated Treasury yields a peak. Both long duration markets are looking through the end of the tightening cycle, and with some relief. In the past, the 10yr yield peaked often with the inversion of the 10y3m yield curve, or earlier, and that curve is now in negative territory by 20bps, and expected to stay there as the effects of policy tightening filter through the economy and bring about a slowdown phase. If inflation does not fall fast, real rates, nominals minus inflation, should remain subdued as well and support gold. Also, the seasonality of the yellow metal is positive in the last two months of the year. It seems we should not be concerned about new highs in longer-dated yields or new lows in gold by year-end.

Fixed Income Update

Market sentiments changed after the softer-than-expected inflation, which helped to spark a rally in US treasuries. The 2-year and 10-year yields saw a 32bps decline on a weekly basis and currently trading at around 4.40% and 3.90%, respectively. The headline CPI rose 7.7% YoY against the market expectations of 7.9%. On a monthly basis, inflation was at 0.4% compared with the 0.6% expected. But the major improvement was seen in core inflation at 6.3% YoY against the expectation of 6.5% YoY. However, Fed Governor Waller, in his more recent statement, pushed back the after-inflation dovish expectation by reiterating that the fed has ways to go before its stops hiking. Markets will keep an eye on US PPI due on Tuesday to assess the economic trends.

Following US CPI, a similar trend was seen in Eurozone, the 10-year yields in both the bund and gilt market were down by 10 and 21 bps, respectively, amid the growth concerns. UK GDP shrank by -0.2% QoQ in Q3 than the estimated -0.5%. The 2s10s in the bund and gilt are inching closer towards inversion and are currently at 8bps and 22bps, respectively.

There has been a lot of turmoil in the Chinese real estate sector. With the few announcements last week, it seems that policymakers are shifting to a supportive stance towards the sector. On 13th Nov, Bloomberg reported that Chinese regulators have sent a 16-point support package to banks across China to support the industry by providing liquidity through additional bond funding, bank funding, restructuring, and focus on completion risk. The package may support strong private developers. Prior to this announcement, NAFMII (a Chinese bond regulator) on 8th Nov announced to expand bond financing support of around RMB 250Bn for private enterprises, including real estate companies. However, as per GS report, they maintain the expectation that China Property HY default will reach 45% for FY22, with a YTD default rate of 39%, and expect that the path of restructuring of stressed companies is a long one. Analysts expect that the slower growth in China will impact the real estate sector growth. Markets will remain volatile and progress in restructuring and liquidity will be key monitorable for identifying the depth of defaults.

Coming to the MENA region, Mashreq bank has issued a mandate for its Tier-II bonds. More primary issuances may be expected from banks in the region. After the IMF deal, Qatar’s sovereign wealth fund deposited USD 1bn at Egypt’s central bank before the planned acquisition in government holdings. Also, inflation in Egypt increased to 16.2% YoY against 15% the previous month.

Equity Update

Last week, global equities gained 6.5% with the Nasdaq leading, up 8%. All US indices were higher for the week, with the S&P 500 +5.9%. Global equities ended last week on a high note, with a big rally on Thursday in US equities and most other markets up concurrently the next day, reacting to a cooler-than-expected October US consumer price inflation report, which lowered expectations on how aggressive the Fed could remain with its monetary policy tightening. EM saw most regions gain, except the KSA and LATAM. China equities were +8% on Friday taking month to date gains of 20%, amid news that China will relax travel restrictions, a 16-point rescue package for the property market, measures range from addressing developers' liquidity crises, blanket debt extensions and loosening down-payment rules for home buyers along with a 20-point playbook aimed at easing the economic and social toll of virus curbs.

Year to date performance for Developed markets is at -16% and Emerging markets -22%. The ongoing turmoil in the cryptocurrency markets is keeping sentiment somewhat in check but positives for the market are US Treasury yields falling along with the US Dollar. The U.S. dollar weakened 4% last week and is now up around 10% against other currencies year to date. Tech performance move inversely to yields and the drop in yields has led to gains for the sector. Energy still remains in favour and the best performer YTD.

The UAE continues to see a broadening of the market with 3 IPO’s currently (offering and listing) across varied industries from education, to district cooling to food retail franchise operators. USD 18 bn raised this year, representing almost half of the IPO money raised in the Europe, the Middle East and Africa (data by Bloomberg).

We had highlighted two catalysts for a market turnaround and the first was a Fed pivot (and a corresponding drop in yields which would help both fixed income and equity markets, especially the long duration tech sector). It’s too early to premise it’s on the cards yet, but data definitely points to cooling inflation on the energy and housing front. However, the jobs market stays strong and October saw 261,00 jobs added, higher than estimates. Fed Chair Powell still sees the labour market as overheated. The US has Democrats having a majority in the Senate and Republicans likely to lead the House of representatives (small majority) is good for equities as it lowers onerous tax legislation. We are overweight US equities and expect further upside if yields compress further or any data that points to inflation subsiding. However, we wouldn’t take big bets as profit growth looks stymied into 2023 and market volatility remains. Just the week before last, equities sold off on hawkish commentary from the Fed following the 75 bps hike and as Mr. Powell suggested the "peak" fed funds rate may be higher than initially expected. This week is important for retail guidance as we get earnings from Walmart and Home Depot. Earnings weakness is starting to materialize across a broader band of industries, with misses coming from a strong dollar, weaker demand, and higher rates. The market is also pricing in a China reopening however COVID cases are on the rise, hence we remain neutral EM Asia.

Written by:

Anita Gupta Head of Equity Strategy , [email protected]
Giorgio Borelli Head of Asset Allocation , [email protected]
Maurice Gravier Chief Investment Officer , [email protected]
Satyajit Singh Fixed Income Analyst , [email protected]

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