Disinflation is not dead

20 May 2024
disinflationisnotdead

AT A GLANCE

  • US April CPI inflation report was a relief for markets, as disinflation resumed in line with forecast.
  • Soft retail sales and manufacturing activity indicators also temper the risk of US overheating.
  • We enjoyed a positive week across asset classes, but still expect high volatility ahead.

The long-awaited signs of moderation in both growth and inflation from the almighty USA are finally gaining enough traction to damp the risk of overheating and its dire consequence for markets, overtightening.

The US CPI inflation report showed both headline and core measures moderating to respectively 3.4% and 3.6% year on year. It wasn’t a surprise, as it exactly matched median forecast, and it wasn’t even a strong drop. But coupled with disappointing retail sales and various signs of softness, from manufacturing activity to confidence, it confirms that a US soft-landing may be finally happening. Markets are yet not concerned about recession risk, for good reasons: unemployment remains low, fiscal support continues (and both presidential candidates should maintain some form of support), and the global picture is not adverse.

There was also interesting news from Asia. Japan’s Q1 GDP disappointed, adding another layer of complexity to their monetary policy dilemma, as the yen suffers from its yield differential with other major currencies. China continues, layer after layer, to deploy support measures for an economy which clearly needs it, especially on the consumption side. The latest initiative is aimed at unsold properties within the critical real estate sector. Time will tell whether this is a game changer, but the +15% US$ return of the MSCI China so far in 2024 is painful to many international investors who were a bit quick to consider China as un-investable. Our tactical asset allocation was kept unchanged in our May Committee: we are overweight cash and safe bonds of reasonable duration to grab low-risk yields, but also stocks, especially from emerging markets, including a small overweight on China. This week will see speeches from central bank officials as well as the FOMC minutes and Nvidia results.

Disinflation is not dead

Cross-asset Update

In China the economy continues to suffer from demand-supply imbalances, as industrial production accelerated, while consumption and investments weakened further as shown in a key economic release at the end of the week. But on Friday Beijing announced its most forceful attempt to support the ailing property market, relaxing mortgage rules and urging local governments to buy unsold homes. While the litany of unhappy analysts that say that more is needed continued, we think that the package is a net positive for China's real estate sector, and that more measures could follow. Investors are much less sceptical, with the MSCI China Index up 15% for the year in local currency, outperforming the S&P 500, that has to-date gained 11%.

The package swiftly followed up after the April politburo meeting. The most significant measure is the bailout program for unsold homes. The PBOC will provide an initial sum of CNY300bn to local governments for them to acquire unsold homes to be used as public housing. While there remains uncertainty as to whether the sector will reach a bottom on the back of the new measures given its three-year decline, government intervention raises those chances sensibly. In the short-term the rally in Chinese equities could stall, as the planned intervention underwhelmed some estimates, and the main benchmarks went up in a straight line. But as long as the valuations gap with DM (or other EM) stock markets remains large, investors will be looking to the July third communist party congress as the next catalyst with room -or fear of missing out- for the further rerating of the Chinese market.

Despite China's lingering woes commodities year-to-date are up in the high single-digits according to the Bloomberg commodity index. This in the end will have repercussions on yields and headline inflation. We have a fair value for the 10-year Treasury yield of 4%, where consensus has now shifted to, that was initially based on three rate cuts for the year, a soft-landing scenario, and consensus inflation forecasts that now have changed significantly as compared to the start of the year. Considering the recent upward inflation surprises, and the reduced number of cuts into year-end, a sharper slowdown would be required to justify the 4% fair value. At first sight this seems unlikely, considering that the Fed from June will reduce the pace of Quantitative Tightening by more than half, capping yields on the one hand and supporting financial markets and the economy on the other. Overall, fair value for the yield on the 10-year note should be somewhere between the current 4.4% and our estimated target of 4% as of the start of the year.

Disinflation is not dead

Disinflation is not dead

Disinflation is not dead

Fixed Income Update

Treasury yields drifted lower after underwhelming CPI and retail sales data prints from the US. Chairman Powell was more hawkish than the last FOMC press Q&A. However, markets have brushed aside the comments. The UST yield curve has bull-flattened with long end-yield dipping by more than 7 bps where as the front-end dipped by 3 to 4 bps.

We held our tactical asset allocation committee meeting last week. We did not make any changes to our current positioning. However, looking at weaker macro data we were in favour of increasing duration to become more neutral. We remain neutral duration due lack of near-term bullish catalysts and risks of a later-than-expected rate-cut. The current average US Treasury duration is 6.1 years and Investment Grade Credit duration is 6.2 years. We recommend holding 5 to 10 year bonds in Investment Grade and 3 to 5 year duration in corporate high yield.

Credit spreads were more rangebound than yields last week. The Investment Grade index spread compressed by 1 bps where as the High Yield spreads compressed by 7 bps. MTD IG supply reached $87bn, suggesting that May total is likely to surpass the historical May average of $120bn. The spread compression in Investment Grade has also been reflected in Financial Vs Nonfinancial issuers. Drivers of this compression include the strong market environment and also a step down in Financial supply. MTD financial bonds make up a third of issuance versus the YTD average share of 40%.

High-yield refinancing activity has gathered pace this year. According to JP Morgan, a considerable $280bn of bonds/loans have been refinanced YTD following $334bn in FY23, a 15yr low $132bn in FY22, and a record $512bn in 2021. Notably, a mere $30bn of HY bonds and loans mature by YE24, which rises to $138bn in 2025, $303bn in 2026, $439bn in 2027, and $844bn in 2028. This implies lower default rates and tight spreads.

GCC issuance has moved to a slower gear since April. Al Dar tapped markets in early May as part of refinancing process and issued a tender for its existing 2025 bonds at 99 cents to a dollar. A total of $38 Bn equivalent of bonds have been issued so far this year from the region. This week Emirates Islamic has issued a mandate to sell a 5-year senior unsecured sukuk. We expect good demand for the issuance given that this is a well-known name and the overall yield for 5-year senior banking sukuks from the region have been attractive recently.

Disinflation is not dead

Disinflation is not dead

Equity Update

We remain constructive equities with a small overweight positioning for both developing and emerging markets. A slight shift with the Eurozone and the UK as overweight within DM allocation, with the US neutral and Japan now underweight. With the Eurozone and the UK seen as the first to cut rate, we see that as a positive boost for corporate margins and sentiment. Our relative positioning within EM is a shift to a China overweight, we retain India and the UAE as overweight. Neutral the rest of Asia and underweight Eastern Europe and LATAM. China looks ready for a rally with the real estate sector finally getting some support, and good tech earnings.

Global equity markets are at record highs with the latest US CPI data indicating inflation is moderating, and the Fed seen to cut rates this year. The MSCI ACWI index, gained every day last week (+1.6% for the week). EM had a better week +2.7%, DM equities gained 1.6%. In the US, the S&P 500 (+1.4%) back at 5,300 and tech which has been lagging this year, has Nasdaq YTD gains higher than the S&P 500 at 11.5%. The VIX, the volatility gauge, ended the week at below 12, the lowest since November 2019. S&P 500 companies’ Q1 earnings, blended growth is 5.7%, with 93% having reported. Surprises reported by companies in the communication services, financials, info tech and consumer discretionary have been the largest contributors to the increase in the earnings growth rate. Analysts have boosted expectations for the upcoming quarter as the economy looks resilient with robust consumer demand, with expected (y/y) earnings growth rates of 9.2%, 8.2%, and 17.4% for Q2, Q3, and Q4 2024. Reports from private unlisted companies with a larger share of domestic vs international revenue mix, soft data has profit margins of 17% in Q1 y/y but wage growth at 5% is a worry. Capex is focused on AI software as for the larger listed companies. Nvidia’s report on Wednesday will be critical for equity markets as it will set and confirm the tone for AI demand, which was recently reinforced by big tech and chips companies, especially TSMC.

European and UK markets had a good week too + 1.6%. Japanese equities TOPIX +0.8%, sentiment boosted by Sony, the third largest component in the index, profits above expectations, robust mid-term plans and shareholder return policy, and a five-for-one stock split.

Within EM, the MSCI China Index, now the best performing large Index YTD, ended the week +4.2%. Tech companies announced good results with gains from Alibaba, JD.com 5% and other China tech. Chinese valuations remain cheap, the MSCI China Index trades at 11.3x forward P/E. Following President Biden's tariffs on strategic Chinese sectors, EV giants like BYD are now looking at Latin America, especially Brazil, as a key market. Within the GCC, SALIK and Spinneys both reported results last week with SALIK posting the highest revenue-generating trips since inception supported by Dubai’s continued growth in tourism, business and commercial activities. Spinneys, recently listed on the DFM, reported record sales in Q1 results last week; and expects to launch in Riyadh in H1 2024, marking its first expansion into Saudi Arabia.

Disinflation is not dead

Disinflation is not dead

Disinflation is not dead

Written by:

IMPORTANT INFORMATION

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, UAE and licensed, 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.

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.