Peak US inflation but choppy waters

Chief Investment Officer's team

22 November 2022

With persistent inflation and resilient activity, tightening from Western central banks is not over

AT A GLANCE

With persistent inflation and resilient activity, tightening from Western central banks is not over…
… But its pace should decelerate from next month, which provides some relief to markets
The big picture supports volatility until a Fed pivot is in sight, which is the true constructive catalyst

The fourth quarter of 2022 continues to be better than the previous ones, and last week was no exception. The Treasury yield curve was probably the best at telling the narrative: interest rates were higher for shorter maturities, expressing an acknowledgment that monetary tightening will continue and last. Meanwhile, longer maturities were stable, expressing prospects of muted growth ahead. Stocks were up in emerging markets, led by China, and only marginally down in developed ones.

Data released last week provided more color to an already known picture. Consumption remains strong in the US, but industrial production is slowing. It is the opposite in China, still struggling with Covid but with positive growth in industrial production. The US PPI confirmed some moderation in inflation, but CPI in Europe printed double-digit year-on-year progressions, due to the combination of an energy crisis with imported inflation from weaker currencies. All in all, the good news is that inflation is slowing in the US and that the supply shocks are undoubtedly fading. We are not done yet, tightening will continue. However, its impact on demand should bear fruits, and a slower pace is justified and should start in the coming months.

Bottom-line, the big picture is unchanged. With uncertainty in China and a shock in the crypto world, we are not done with volatility. The true catalyst, which is a Fed pivot, probably requires softening in US job market which hasn’t happened yet. Meanwhile, as valuations are reasonable and sentiment still pessimistic, we are more neutral than outright cautious. We own cash, are close to neutral on stocks and favor govies within fixed income. In the week ahead, we will decipher the Fed minutes and look at flash PMIs in the West. Stay safe.

Cross-asset Update

Investors are cheered by the rising odds of peaking US inflation, welcome across asset classes, from equities, to government bonds and gold. The S&P 500 has rallied in the low double digits from the October lows, longer-dated yields have fallen sharply, while gold is trading close to a three-month high. One is now tempted to look at the glass half full, in spite of the failures of the previous bear-market rallies, and look through the current sequence of Fed’s hikes. In the past, inflation peaks preceded equity market bottoms more often than not, and the latest innings of the tightening cycle saw longer-dated yields peak out. Such a combination seems to be quite bullish for risk assets in general, and money markets are yet again discounting looser monetary policy in the United States, specifically towards the end of 2023. Also, China will at some point slowly relax covid restrictions, and the property sector is being supported. But being unconditionally optimistic would amount to be rushing to conclusions, in our view.

Granted, with the worst of inflation and yields’ upward momentum behind us, it would be right to be less pessimistic about the market outlook, but maybe just a little less so. Looking at the glass half empty as well, as the effects of higher rates make themselves felt through the economy, focus will be shifting from valuations, not outright cheap, to earnings, set to slow markedly despite the recent downgrades for 2023. With all of the relevant yield curves inverted, including the one the Fed watches closely basically measuring shorter term rates eighteen months in the future, and the Conference Board Leading Index in negative territory for three months running, the odds of a recession in the next 12 months have increased significantly. Since the Great Depression no equity bull market has ever occurred before a recession even started, hence we hold the view that stock gains should be capped until the outlook has improved. Exceptions were the 1968 and 1987 bear markets, much shorter than twelve months and marked by no contraction in the economy. The Chinese growth impulse may not be strong enough to fully offset the numerous crosscurrents, hence Beijing’s countercyclical policies might only help so much.

In summary, the outlook across asset classes seems to be complex to navigate, with equities range bound until we get to know whether worsening economic conditions will be looming larger; and government bonds and gold moving sideways as well, till it becomes clear, sometime in the first half of 2023, whether inflation is sticky and more hikes are needed, or it is rather going to fall in line with expectations. Higher-quality bonds still offer the best risk-reward ratio across asset classes, with DM investment-grade corporate bond yields close to 5% and the possibility that longer-dated yields are peaking out, as against a still uncertain growth outlook not outright supportive of risk assets. Gold is attempting to bottom out, and we will be warming up to it in 2023, with the yellow metal usually in a bull trend in times leading up to sharp slowdowns.

Fixed Income Update

October CPI surprised on the downside leading to the largest rally for the US Treasuries in more than a decade. However, Fed officials continue to try to moderate market expectations of a quick pause or a turnaround. From the declaration such as "we have a ways to go" from Waller, to the message by NY Fed president John Williams that restoring price stability is of "paramount importance", we get a clear sense of the Fed’s pushback. Fighting the Fed is never a good idea though investors time and again love to test the hypothesis. Even though yields have come down, we see investors flocking to the long end of the curve. The neglected part of the US Yield curve, the 20-year bond auction last Wednesday saw high demand indicated by the bid/cover of 2.64, which was solidly above average, and indirect allocation of 75.3% was a complete 1.2 sigma above the one-year average. With an expected Fed Funds rate close to 5%, a recession will be difficult to avoid unless the Fed more meaningfully pivots. The inverted 2s10s part of the curve indicates this.

According to a recent S&P report, the number of weakest links, issuers rated 'B-' or lower by S&P Global Ratings with negative outlooks or ratings on CreditWatch with negative implications, increased to 239 in October from 220 in September, boosted by an increase in downgrades to 'B-' or lower. The number of 'B-' rated issuers with negative outlooks or CreditWatch placements is rising and is now higher than at this point in 2021 and currently near 10% of the overall HY-rated issuer universe. The low refinancing requirements are the only aspect keeping a lid on actual defaults. A manageable $262bn of high-yielding bonds and leveraged loans mature in 2023/24, which rises to $427bn in 2025, $502bn in 2026, and $488bn in 2027 in the US HY segment. A JPM report mentions that 1,986 high-yield bond and loan companies (81%) have no maturities before 2025. But there is a heavier debt burden for lower-rated issuers over the coming years. Near-term maturities (2023-24) comprise $84bn of BB bonds and loans, $99bn of Single B, and $79bn of CCC-rated issuers.

After a long break, the Middle East primary markets saw a slew of deals and mandate announcements from the financial sector. Last week, Banque Saudi Fransi priced a 5-year $700mn bond at a 5.58% yield. Mashreq Bank priced a 10.25NC5.25Tier 2 $ bond at a 7.95% yield. Both the deals saw decent investor interest, and spreads tightened by around 25 to 30bps from IPTs to final pricing. In addition, DIB has issued a mandate for a debut 5-year sustainable Sukuk expected to price this week.

Equity Update

The month of November so far, has seen global equities gain with China recently rallying from oversold conditions with 3 consecutive weeks of gains. The MSCI China Index was up last week bringing November gains to +25%, though China remains the worst performing large market at -30% year to date. The Golden Dragon China Index of US-listed China companies rose in tandem as did real estate stocks which have been particularly hit by a slowdown in the housing sector. China equities have been supported by recent Covid travel regulations relaxing, property support measures, a positive Presidents Biden and Xi meeting, expectations for more policy fine-tuning following soft October data and firmer online retail sales data. We remain neutral China as we see a rise in COVID cases affecting reopening plans and also whilst tech companies rallied recently the onerous oversight of monopolistic enterprises or those with large sets of data on China users is not going away even though less onerous. Valuations are attractive, but consumer demand is essential for profitability growth. Also, Presidents Biden-Xi meeting while constructive , saw no resolution of any major issues and Taiwan remains a source of discussion. Our preference remains for the UAE and India in the emerging market space.

Our region saw the KSA and UAE equity indices down last week though new listings continue to see tremendous demand. Empower listed successfully on the Dubai bourse and both the KSA and UAE continue to see issuance. Abu Dhabi’s USD1.4bn IPO Fund shortlisted six private sector companies to potentially receive investment and advisory services for listing their shares on the Abu Dhabi Securities Exchange and is in discussion with 30 other companies to list on the capital’s stock market, expected to come to the market by the end of the first half of next year. The Americana IPO is currently underway. Indian equities fell 1.7% last week and have not seen much upside in November, though still positive year to date in local currency terms.

We are 6 weeks away from the end of 2022, a year that started with elevated valuations and then saw the market battered by higher commodity prices, labour costs, supply chain constraints and rate increases. 2 of these 4 variables are now improving. While the European industry is seeing the effect of constrained energy supply and higher costs, oil and essential commodity prices have fallen 20 to 30% from peaks earlier in 2022. Oil prices declined last week as OPEC revised their forecast for global oil demand lower for the fifth time since April, as uncertainty rose around Chinese demand. Also, the supply chain (shipping) is largely back on track as is production in most parts of the world. However, labour shortages in the blue-collar space are still concerning though tech layoffs while in the headlines, are not really a game changer. Monetary policy is also not yet pivoting and rates will rise till inflation is under control. The US saw the S&P 500 lose some of its recent steam, falling 0.5% last week, giving up gains from earlier in the week as Fed officials commented on the need to bring rates further into restrictive territory. European equities rallied despite fiscal policy in the UK revealing possible future spending cuts and tax hikes. We retain our US preference in the developed market allocation.

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]

Disclaimer

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), a public joint stock company incorporated in Dubai, United Arab Emirates (UAE) and licensed to provide various financial services including promotion, financial consultation, securities portfolio management, managing investments of investment funds, etc. Emirates NBD is regulated supervised and controlled by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”), having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

This publication is prepared without regard to the individual financial circumstances and objectives of persons who receive it. Data/information provided in this publication are intended solely for illustrative purposes for the general information or its recipients, irrespective of their customer classification as an Ordinary Investor or Professional Investor under the SCA Regulations.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accept any responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they may not be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor.

Where this publication provides any information about Shariah compliant products, the Bank will not have engaged a Shariah board (or similar body) to determine independently whether or not such products are compliant with Shariah principles. The Bank accepts no liability with respect to the fairness, correctness, accuracy, reasonableness or completeness of any such determination or guidance by any Shariah board that has certified or otherwise approved such products as Shariah compliant. Nothing contained in this publication shall be construed as a recommendation by the Bank to invest in such product. In deciding whether to invest in Shariah compliant products, you should satisfy yourself that investing in such products will not contravene Shariah principles. You should consult your own Shariah advisors as to whether investing in such products is compliant or not with Shariah principles.

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investor may lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.

more app