3 February 2023
Weekly Market View
Nearing the end
This week, three of the world’s most powerful central banks raised rates to new 14-year highs and signalled they are likely to hike at least once more and remain restrictive for a while. However, markets chose to look at the bright side – that the sharpest series of rate hikes in more than four decades is nearing its end.
We are more sceptical about the outlook for risk assets. We now expect the Fed and ECB to raise policy rates to 5% and 3.0-3.25% respectively in H1 and maintain them near the peak for the rest of the year. This is likely to impact equity valuations and corporate earnings.
This macro backdrop, combined with stretched investor positioning, argues for fading the rally in US and Euro area equities and looking for opportunities to rebalance to bonds and stocks in Asia ex-Japan, where the outlook is brightening.
We also see further USD downside and broadly stable US bond yields near term, which should support flows to Asia.
Is further consolidation likely in the Hang Seng index?
What is the outlook for US government bond yields after the latest Fed meeting?
Are you still expecting a near-term bounce in the USD?
Charts of the week: Breaking higher?
S&P500 index broke above a key technical resistance, even as the Fed tightened its policy rate above inflation
S&P500 index, with next key technical resistance levels
Fed rate, US core inflation (personal consumption expenditure)
Source: Bloomberg, Standard Chartered
Editorial
Time to fade the rally in Europe
This week, three of the world’s most powerful central banks raised rates to new 14-year highs and signalled they are likely to hike at least once more and remain restrictive for a while. However, markets chose to look at the bright side – that the sharpest series of rate hikes in more than four decades is nearing its end. US stocks broke above key resistance and European stocks rose to a nine-month high, having recovered more than four-fifths of the losses since the end of 2021.
We are more sceptical about the outlook for risk assets, though; we now expect the Fed and ECB to raise policy rates to 5% and 3.0-3.25% respectively in H1 and maintain them near the peak for the rest of the year even as economic data deteriorates. Restrictive rates and wage gains are likely to impact equity valuations and erode corporate margins, leading to earnings estimate downgrades. This outlook confirms our SAFE asset allocation stance at the start of the year: staying overweight on higher grade bonds and other income assets at the expense of equities. Add to that crowded investor positioning (see page 10), and we would continue to fade the rally in US and Euro area equities and look for opportunities to rebalance to bonds and stocks in Asia ex-Japan, where the outlook is brightening.
Of course, our latest review of the macro environment indicated several improvements since late 2022:
a) Headline inflation has peaked in major economies, enabling central banks to slow the pace of (and in some cases end) rate hikes; b) China and the Euro area economies are recovering, aided by policy stimulus and a plunge in gas prices (the IMF this week bumped up 2023 growth forecasts sharply); c) A weaker USD is easing global financial conditions and risk sentiment; d) Institutional investor positioning remains bearish on equities (although less so since Q3 last year); e) As a result of the above factors, risk assets are pricing in a goldilocks scenario of a shallow downturn in the US and Euro area, without severe dislocation to job markets and consumption as inflation gradually settles back towards central bank targets.
Nevertheless, we believe the scenario that markets are pricing in, extrapolating the above improvements, is too optimistic:
a) Global growth is set to slow this year as policy rates become restrictive, even as the dire outcome in Europe has faded; b) the US economy is slowing decisively (this week’s contractionary ISM Manufacturing and New Orders PMIs attest to that); c) Yet labour markets in the US and Europe remain tight (as seen in bigger-than-expected rise in US job openings, drop in initial jobless claims to near-record lows and Euro area jobless rate staying close to near-record lows); d) Core inflation, especially in services sector ex-housing, remains high in the US and continues to rise in Europe; e) China’s recovery is likely to add almost 0.5-1 percentage points to global inflation, challenging the disinflation narrative in the coming quarters; f) Corporate earnings are likely to slow as margins tighten, while earnings estimates have yet to be downgraded significantly; g) Expectations of an economic soft-landing and central bank policy pivots are contradictory – central banks are unlikely to cut rates if the economy and job markets don’t deteriorate sharply. Central banks are also unlikely to tolerate a significant easing of financial conditions (through higher stock markets and narrower HY spreads) before the inflation battle has been won; and h) several risk assets are showing one-sided investor positioning, raising the risk of a near-term reversal. These include Europe and Asia ex-Japan stocks, the EUR and gold.
Investment implications: On balance, we believe many risk assets have likely run ahead of fundamentals. While strong momentum points to near-term upside for US and Europe equities, we would look for opportunities to switch to Asian ex-Japan equities (see page 5). We also see further downside for the USD and broadly stable US bond yields in the near term (see page 4), which should support flows to Asia.
— Rajat Bhattacharya
The weekly macro balance sheet
Our weekly net assessment: On balance, we see the past week’s data and policy as neutral for risk assets in the near term.
(+) factor: Easing US inflation, resilient Euro area economy
(-) factor: Falling US PMIs, hiking central banks, geopolitical tensions
US manufacturing activity continued to deteriorate, but the job market remained robust
US ISM Manufacturing and new orders PMI, US job openings (JOLTS)
Euro area headline inflation continued to decline with falling energy prices, but core inflation remained elevated
Euro area headline and core inflation
China’s economic activity rebounded strongly in January as mobility restrictions were removed
China manufacturing and non-manufacturing PMIs
Top client questions
Are you still expecting a near-term bounce in the USD?
We have revised our near-term (three-month) outlook for the USD modestly lower and other major currencies higher following the Fed, ECB and BoE meetings earlier this week.
Fed Chair Powell appeared to be less hawkish relative to our expectations after slowing down the pace of rate hikes. Since multiple economic data indicators continue to point towards a slowdown in growth and inflation, we believe the Fed is likely to be under pressure to cut rates late in 2023, which means that markets are likely to push the USD lower in anticipation of rate cuts. Hence, we look for a modest downside in the USD in the next 3 months.
Our upward revision in ECB rate hike projections, along with an improvement in the energy security situation in Europe and positive growth surprise in Q4 growth, lead us to revise our near-term EUR/USD forecast higher to 1.12. A narrowing of real interest rate differentials with the US and positive investor sentiment are likely to be supportive for the common currency.
We also expect near-term strength in the AUD, NZD and CAD as the commodity currencies are likely to benefit from the faster-than-expected re-opening in China. As we head closer to the end of BoJ Governor Kuroda’s term in April, market expectations of a shift in monetary policy are likely to push USD/JPY lower.
— Abhilash Narayan, Senior Investment Strategist
We revise our 3-month forecasts for the USD and other major currency pairs
Revised 3-month forecasts
Our assessment of the current global macro backdrop and its impact on risk assets
— Zhong Liang Han, Investment Strategist
Top client questions (cont’d)
Is further consolidation likely in the Hang Seng Index?
We believe the medium-term case for rising Chinese equities remains intact. This is because we believe the four factors that drove the downtrend in the Hang Seng Index since Q1 2021 – properties, internet regulations, threat of ADR delisting in the US, and mobility restrictions – are likely to continue to subside.
However, a pullback is likely in the short term (1-3 months). Chinese equities have become a consensus overweight. While the index has been climbing for most of January, volume has not been increasing, suggesting a lack of sustaining power in the rally. Moreover, there is risk from short-term fund rotation back into US equities. Nearly half the companies in the S&P500 index have reported earnings thus far, with 70% beating consensus estimates, giving a positive earnings surprise of 2.2%. The S&P500 index has just broken above a key resistance level at 4,100, propelled by a dovish FOMC meeting.
Hence, technicals argue the S&P500 index may have more room to run, possibly reaching key resistance levels at 4,325 and 4,512. We believe it will become more attractive to consider rotating back into the Hang Seng Index once the S&P500 index approaches these resistance levels, especially if the Hang Seng Index reaches key support levels at 20,300 and 19,300.
— Daniel Lam, Head, Equity Strategy
The Hang Seng index could see a pullback towards the “support zone” around 19,300 to 20,300
Hang Seng index
What is the outlook for US government bond yields after the latest Fed meetings?
The February Fed policy meeting concluded with Fed Fund Rate being raised by 25bps and the statement reiterating the need to hike rates further as inflation remains above long-term target. However, the market focused on the dovish takeaways in the post-meeting conference, resulting in US government bond yields falling. At his speech, Fed Chair Powell said he recognized disinflation has started and appeared to be relatively unconcerned about the discrepancy between market expectation and the Fed dot plots.
We revise our 3-month 10Y US government bond yield target lower to 3.25% – 3.5%. In our view, markets are likely to continue to look through forthcoming Fed rate hikes if Chair Powell continues to refrain from fighting the market. Macroeconomic data continues to deliver a mixed picture. Although the US labour market showed signs of lingering tightness, leading indicators are pointing towards higher downside risk to the economy. In addition, bond technicals favour largely anchored yields, which we believe will remain in place through to the last Fed rate hike of this cycle.
The 10-year yield is currently testing key support level of c.3.3%. Nonetheless, the building up of net short future positions since the start of the year should help yields from breaking substantially lower. Hence, we see high likelihood that the 10-year yield trades in range going forward, as we retain our year-end target at 3.25%.
— Cedric Lam, Senior Investment Strategist
Net short positions in US 10-year government bonds have surged since the start of the year
US 10-year government bond yield and net futures positions
Top client questions (cont’d)
What is the implication of India’s budget on markets?
India’s budget surprised markets by taking significant steps to spur growth while maintaining fiscal prudence. Announced measures to boost growth include: 1) Higher capital expenditure: FY 2024 capital expenditure is forecast to increase by 33% to a record USD 123bn (c.3.3% of GDP), with a focus on key infrastructure sectors such as railways and roads; 2) Boost to manufacturing, with the doubling of allocation for manufacturing subsidies. This follows other long-term reforms (such as corporate tax cuts, import duty changes and the production-linked incentive scheme) initiated in recent years as part of the push to develop India as a global manufacturing hub; and 3) A cut in personal income taxes could boost middle class disposable income and spur domestic spending, aiding economic recovery. These measures were balanced by the government sticking to its fiscal consolidation path, with FY 2024 budget deficit set at 5.9% of GDP vs 6.4% of GDP for FY 2023. More importantly, the shift in the quality of spending towards capex and cuts in subsidies towards pre-pandemic levels are likely to support India’s macro fundamentals.
A pro-growth budget that also maintains fiscal prudence is likely to keep inflationary expectations muted. India’s growth-inflation dynamics remain superior to that of its peers, which could better support its assets against external shocks. Indian equities have struggled this year to replicate their spectacular outperformance vs Asia ex-Japan in 2021 and 2022 given elevated valuations. We expect Indian equities to perform in line with Asia-ex Japan equities.
However, in our assessment, still-robust earnings growth, possible return of foreign investment flows and resilient domestic inflows through stable systematic investment plans are key supports for equities. Within Indian equities, we are Overweight large-cap equities. The budget is likely to support structural equity themes that have a longer runway for growth. We continue to see attractive value in financials, domestic cyclicals, and investment-led themes mainly focused on the manufacturing and infrastructure sectors.
Bond yields are likely to trend lower, with the budget unlikely to be inflationary given the improving quality of spending. Furthermore, with inflation trending lower over the last few months, interest rates are expected to peak out with consensus expecting the RBI to deliver its final rate hike in the current cycle at its February review next week. We continue to see increasing value in bonds, especially relative to equities. The budget is mildly positive for the INR as continued fiscal consolidation, strong focus on capex outlay and lower market borrowings are supportive for Indian assets. However, near-term risks remain on the downside for the INR given still-wide trade deficit, foreign portfolio outflows from equity markets, and likely RBI intervention as it tries to rebuild its FX reserves.
— Vinay Joseph, Head of Investment Products and Strategy, India
India’s government stuck to fiscal consolidation path; significant increase in capital expenditure
Key numbers from the Indian federal budget
Trends in India’s equity sector earnings estimates
Sector EPS trends since the start for FY23
Market performance summary*
*Performance in USD terms unless otherwise stated, 2023 YTD performance from 31 December 2022 to 2 February 2023; 1-week period: 26 January 2023 to 2 February 2023
Our 12-month asset class views at a glance
Economic and market calendar
The S&P500 index faces next resistance at 4,234
Technical indicators for key markets as of 2 February close
Investor diversity has deteriorated in Europe stocks
Our proprietary market diversity indicators as of 2 February
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