Global equities continued their sell-off over the last week as a combination of higher real yields and the risk of a bigger than expected slowdown in China weighed on risk assets. Markets’ main focus is currently on China, the conflict in Ukraine and US monetary policy. In the coming weeks, attention is likely to shift more towards corporate earnings as analysts try to estimate the impact of higher input costs and slowing growth on corporate profitability.
Bond market rout continues
Over the last week, yields of US Treasuries have risen sharply after another streak of hawkish Fedspeak ramping up rate rise expectations.
Fed Chair Jerome Powell said that a 50bp increase “will be on the table for the (3-4) May meeting” of the Federal Open Markets Committee, while San Francisco Fed President Mary Daly said that a 75bp rise will be something she will deliberate with her colleagues at the meeting.
Loretta Mester (FOMC voting member) and Charles Evans (non-voting member) have signalled support for a 50bp hike in May, while James Bullard (voting member) has indicated openness to a 75bp rate rise.
Markets (overnight indexed swaps) are now fully pricing in 50bp increase at the May, June, and July FOMC meetings, with the fed funds rate priced at 2.70% by year-end.
Our fixed income team anticipates the Fed will move even faster, taking policy rates to 3.25-3.50% by year-end 2022 with additional increases possible in 2023.
US GDP contracts in first quarter
Data released today showed US economic growth unexpectedly contracted in the first quarter amid growing trade imbalances, rising inflation and supply chain disruptions.
The US commerce department reported that gross domestic product dropped by 1.4% on an annualised basis in the first quarter, a significant fall from the 6.9% rise recorded in the fourth quarter of 2021. This marks the first contraction of the US economy since mid-2020, when Covid-19 lockdowns had curtailed activity. The data translates into a 0.4 % fall compared with Q4 2021.
In our view, the headline GDP figure belies ongoing strength in US household income. Personal consumption grew by 2.7 % in the first quarter, up from 2.5% at the end of 2021. That was nevertheless weaker than the forecast 3.5%.
The strength in consumer spending was offset by a growing trade deficit, which hit a record high in March as import volumes and prices surged. The robust import demand, and the change in the trade deficit, detracted from GDP, because it is a gauge of production.
A revision to how retail sales are calculated — announced by the Census Bureau this week — also curtailed growth in the first quarter, and is expected to bolster GDP in the second quarter.
China struggles with Covid
China reported 14 222 domestic Covid-19 cases on 26 April, declining for the fifth day. However, the situation has worsened in Beijing.
Covid lockdowns have dented China’s economic prospects since mid-March. Despite this, the authorities have shown little indication of relaxing their zero-Covid campaign.
China’s Covid lockdowns have raised more concerns on growth expectations and hence on demand, negatively affecting commodity prices.
Overall, it is our view that if this outbreak continues to disrupt supply chains, contract activity and weigh on new orders, policymakers in Beijing will respond with policy stimulus.
Emmanuel Macron re-elected in France
Macron’s victory in the presidential election ensures a degree of continuity in the economic and political landscape. Indeed, his victory bodes well for further progress on EU integration and security cooperation.
In foreign exchange markets, where the US dollar rose this week to a five-year high at USD 1.0524 against the euro, this result alone may not be enough to elicit a big move higher in the euro against the dollar, but the Macron victory removes a key downside risk at a time when valuations and positioning are stretched.
The euro and other currencies (the DXY dollar index measuring broad dollar strength against a basket of currencies has pushed up to its highest point since 2017), have declined steadily since early February as markets responded to increasingly hawkish signals from the US Federal Reserve.
While markets have begun to price in an end to ultra-loose monetary policy in the eurozone, the European Central Bank (ECB) has been expected to tread carefully, given the exposure of the region’s economy to soaring energy prices that could conceivably rise further.
Markets price significant probability of ECB rate rise in July
Last week’s ECB speakers struck quite a hawkish tone. Several were at the very least open to a rate rise at the meeting of the ECB’s governing council in July, while some actively called for one.
Better-than-expected April Purchasing Manager Index (PMI) data suggested the eurozone economy started Q2 on a stronger than-expected footing. This possibly triggered comments from the more hawkish members of the governing council. The market is pricing in an 86% probability of a 25bp rate rise in July, which we think unlikely.
Earnings now key
For first quarter 2022 (with over 20% of S&P 500 companies reporting), 79% of companies have posted a positive earnings-per-share (EPS) surprise, while 69% have reported a positive revenue surprise.
The blended earnings growth rate for the S&P 500 is 6.6%. If 6.6% is the actual growth rate for the quarter, this will mark the slowest rate reported by the index since the fourth quarter of 2020. That said, earnings growth would still be positive and supportive of US equities.
European equities have now seen 10 consecutive weeks of outflows and sentiment remains poor.
Our multi-asset team has moved to an underweight in European equities. The key for direction from here is, in our view, earnings. Almost a third of Stoxx Europe 600 index companies will be updating their earnings and sales in the coming days.
This earnings season comes at a challenging time given the fallout from the Russia/Ukraine conflict, a possible hawkish turn in monetary policy and surging inflation. Under these circumstances, earnings resilience is likely to be rewarded.