Slower, higher, longer monetary tightening

Chief Investment Officer's team

07 November 2022

Slower higher longer monetary tightening

The US Fed hiked interest rates by 75 basis points as expected last week but delivered a hawkish message

AT A GLANCE

The US Fed hiked interest rates by 75 basis points as expected last week but delivered a hawkish message
The pace of tightening will slow but to reach a higher terminal rate and stay there probably longer
Markets instantly fell, but recovered later with signs of slowdown in the US economy

Another eventful week just ended. The US Federal Reserve held their crucial policy meeting, and if the decision was widely expected, with another jumbo +75 basis points interest rates, chairman Powell’s message during the press conference was undoubtedly hawkish. While he acknowledged that the pace of interest rates will slow “at the next meeting or the following”, he also warned that the terminal rate needed to fight inflation will certainly be higher than initially thought. He also confirmed that no rate cuts will happen before inflation is convincingly back on track. This killed hopes from previous weeks for a softening in the tone and in the intention, in a painful wake-up call, especially as the official statement mentioned for the first-time the lag between tightening policy and its economic impact.

Coincidentally, the week was also rich in terms of economic data. Leading indicators were disappointing in China, and Europe confirmed a difficult situation with a slowdown in activity but no relief on inflation, as the CPI came out higher than expected. Coming to the US, the ISM manufacturing was modestly better than expected, just above the contraction level at 50.4. Services however came out below expectations. Bad news for the economy are good news for markets, and this was only confirmed Friday with less jobs being created in October than the median forecast.

Weekly returns remained overall negative, but it could have been worse, especially as Chinese stock markets had a strong rebound, which we believe is more linked to excessive pessimism than to actual catalysts. Volatility remains the name of the game, and the change in regime we are all hoping for may also take longer and be slower than initially thought. Stay safe.

Cross-asset Update

It was a negative week for US equities in the wake of the hawkish message delivered by the Fed at the November policy meeting, yet the major stock markets closed in positive territory and some cross-asset relationships remain at odds with general negative investor sentiment. Going by the numbers, heavyweight technology stocks led the bulk of the US benchmark losses, with the Nasdaq down 5.7%, but deep cyclicals like industrials and materials were up in the five days through Friday, hence driving the outperformance of the Dow Industrials, that lost 1.4%. Non-US markets actually put in quite some gains, as Europe gained 1.5%, and the UK 4%, although the BOE raised its benchmark rate, and the MSCI EM index rose by 4.7%, on rumours of China reopening. Gold ended 2.2% higher, in spite of Powell’s message, while The US dollar index was little changed for the week, but slumped on Friday following a jobs report starting to show some cracks in the US labor market. Overall it seems that, barring the fall in technology suffering from the fallout from a disappointing earnings season and heightening the general level of volatility, intermarket relationships did not paint such a dire picture.

Across earnings, rates and macros, no obvious positive trigger comes to mind, if not the possibility that the Chinese authorities ease Covid restrictions and open the economy. Although the health authorities have reiterated that zero-covid policies will be unswervingly adhered to, some market pockets are trading as if this is true, with both global industrials and materials, and Europe, most exposed to China, in positive territory in the five days through Friday. Also, EM CDS spreads peaked in July and have since inflected lower, alongside more comprehensive measures like the Citigroup EM Macro Risk Index. Such an event initially would undoubtedly boost global growth in a non-inflationary way, unclogging the transmission channel of the expansive credit policies that to-date have had little impact in China due to the existing restrictions. Second-round effects would be less welcome, as growing commodity demand would be contributing to inflation and give even more headaches to DM central banks. The reopening trade may breathe some life in EM equities, so oversold that any positive news flow can trigger a rebound.

Interestingly, gold failed to make new lows for the year following Powell’s hawkish turn, and actually closed above the previous two weeks’ highs on Friday. Markets for the time being could be betting on a shorter monetary cycle, a cycle investors are all too eager to look through. Could it be that the Fed hikes 75bps in December, downshifts to 50 in January and then it is done? Maybe, so that they rapidly reach their target rate, not incurring the mistake of having to revert to larger hikes if inflation surprises to the upside. We do not know whether a Fed funds level around 5% will be actually enough to quash inflation, but meantime gold can rally, as investors chase the end of the monetary cycle in their minds.

Fixed Income Update

The FOMC rate decision did not shock anyone, but Powell's press conference did the trick. The previous week's bullish sentiment was driven by expectations of a 50bps move in December and dovish muttering from the non-Fed central banks. However, the declaration that the Fed will need to hike rates more than anticipated in the Dot Plot, pushing back against any notions of premature pauses, and confirming that the Fed is ok to deal with conditions arising from overtightening rather than let go of inflation, affected sentiment negatively. Moreover, markets realized that moving to a lower gear doesn't mean a pivot or end of the cycle, particularly as the NFP data showed last Friday that the labour market remains strong.

The front-end yields rose, and the curve flattened, unwinding the previous week's moves and more. The 1 and 2-year yields are now close to 4.7%. The 10-year yields hover around 4.17%. The 2s10s part of the curve had deepened its inversion while the 3m10y part is close to inversion. All of this points towards a challenging 2023 for risky segments in the fixed income. BoE followed with a 75 bps rate increase but a dovish tone by Governor Bailey. The Governor firmly pushed back against market expectations for the scale of future increases, warning that following that path would induce a two-year recession. This sets the Fed apart from the other two big central banks, ECB and BoE. The ECB had earlier provided some assurance to the analysts after the 75 bps hike last week, which was considered dovish.

High Yield was surprisingly resilient in the face of such hawkish onslaughts. Supply also remains light and is down 78% YoY, earnings are better than expected, and the retail mutual fund base reported its largest inflows ($4.28bn) in 14 weeks, according to a JPM report. As the Bloomberg Barclays index shows, the U.S. High yield bond yields increased 25bp, and spreads decreased 3bp over the past week to 9.38% and 462bp, respectively. The 25-year average default rate for BB, B, and CCC-rated bonds is 0.7%, 2.6%, and 6.7%, respectively, compared to implied default rates based on current spreads of 0.1%, 2.2%, and 7.7%. The average default rate for BB, B, and CCCs in a recession is about 2%, 7%, and 14%, respectively.

The U.S. distress ratio, the proportion of speculative-grade (rated 'BB+' or lower) issues with option-adjusted spreads of more than 1,000 basis points (bps) relative to U.S. Treasury, increased to 7.6% as of Oct. 17, from 6.6% as of Sept. 22, 2022, according to S&P. As movements in distress, the ratio can run roughly parallel to movements in the U.S. default rate (with several months lead time). S&P believes the U.S. trailing-12-month speculative-grade default rate will rise to 3.5% by June 2023 from its current levels of 1.6% in case of a shallow recession.

Equity Update

Emerging markets rallied last week with China equities gaining 11%, including a corresponding rally in the Hang Seng index and the Golden Dragon China Index (China companies listed in the US). Other EM too had a good week i.e. LATAM, India and the UAE. On the Developed Market front the US had a down week as the Fed delivered a hawkish message and the strong labour market was seen as a trigger for continued Fed rate hikes. Midterm election results should impact the market only if vastly different from expectations. Europe and Japan had a positive week and the US was the outlier amongst global market performance.

Whilst reopening news on China remains mixed, we expect a pick up from oversold levels for equity indices with the MSCI China trading at 10.3X forward Price to Earnings. We have remained neutral EM Asia (including China) the last few months and would stay with that view. However, having held China equities through the selloff investors should get benefits of near term upside. From a strategic and even more fundamentally driven tactical call we continue our preference for India and the UAE. We may see smaller gains into year end, but India remains a growth story and equity performance continues to be driven by growing consumer demand, inflation that is not too far away from Central bank targets, hence some stability on rate hikes. The UAE remains a dividend play and one of the few markets globally attracting investments into new listings. Capital comes at a premium when rates rise as seen by the limited off take recently in venture capital raisings in Silicon Valley. Tourist inflows into the UAE on the back of the Qatar World Cup will enhance the service sector growth and are a good diversifier to oil revenues. This year Hotel Rev Pars (average Room Rates) are already up in spite of the AED peg to the strong USD.

The Nasdaq 100 had the second biggest weekly drop this year, back to mid-2020 levels, as technology stocks fell in reaction to the Fed message on raising interest rates further to tame inflation. Performance of longer duration growth stocks, like tech, are based on expected future earnings, which are devalued when interest rates rise. Also Big Tech earnings have exhibited weakness this quarter. Semiconductor companies’ guidance point to a slowing growth outlook, with Qualcomm, a leading mobile-phone chip supplier, reducing smartphone shipment forecasts in line with Apple lowering forecast for shipments as its China factory faces lockdowns. Advanced Micro Devices sees lower revenues and Intel ongoing cost cutting and layoffs. Amazon is pausing hiring. Facebook has guided on lower digital ad revenue and Amazon, Google and Microsoft on cloud services growth slowing. Large job cuts at Twitter under the new leadership of Elon Musk add to the tech malaise. Currently financials and energy (both traditional oil producers and clean energy such as hydrogen) provide a better risk reward outlook. Bank profits whilst affected by slowing credit and consumer defaults should be offset by the higher rates impact on Net interest margins. Banks with higher CASA will benefit the most such as the UAE. Oil companies have record profits this year and are investing in greener initiatives, diversifying their income streams. Both sectors are also strong dividend payers.

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