Switching gears

Chief Investment Officer's team
07 February 2022
Switching gears
Last week confirmed a broad hawkish shift from Western central banks, at rapid pace.


  • Last week confirmed a broad hawkish shift from Western central banks, at rapid pace.
  • Markets didn’t overreact, as they also noted resilience in growth and corporate earnings
  • We will hold our 2022 Global Investment Outlook webinar this Wednesday 9th of February

The week which just ended may be important for the rest of the year. While the earnings season continued to be broadly good in the background, headlines were about economic data and central bank policy meetings. Most economic indicators painted a picture of resilience, and even more in the US employment market, with an extremely positive surprise in the US non-farm payrolls report for January. 467,000 new jobs were created in January, which is more than 3 times the median forecast, while December was revised up from 199,000 to 510,000. This is buoyant, despite Omicron.

Employment and inflation are the core two pillars of central bank mandates. Last week both the ECB and the BOE followed the Fed in a clear hawkish shift. The ECB in particular could finally start hiking interest rates in 2022, which was previously explicitly excluded. Market reaction was not extreme. Interest rates rose, without overshooting, and stocks had a positive week everywhere. The earnings season remains healthy, even if individual stock reactions shows investors’ nervosity. Any miss is heavily punished, while modest beats do not trigger any euphoria. Gold, surprisingly, had a positive week as well.

Our reading is that market participants have started to react more fundamentally than emotionally: growth is robust, and the policy normalization is extraordinary only because the starting point is extraordinary. Indeed, most of policy stances should remain accommodative in absolute in 2022. Finally, behavioral factors matter: the popularity of asset classes in portfolios explain a good part of their 2022 returns so far.

We hope to welcome you at our 2022 Global Outlook webinar this Wednesday. Stay safe.

Cross-asset Update

Tremors related to the removal of liquidity carried out by central banks in tightening mode are starting to make themselves felt across asset classes. The Federal Reserve is leading the pack, others are joining in, like the Bank of England, or will be following suit further down the road, like the ECB. The first-round effect is that real rates will be rising further, as they usually do during tightening cycles, causing long duration assets and equities to struggle. Also, the pool of negative-yielding bonds is quickly shrinking, mitigating the search for yield along the risk curve. In Europe, where longer-dated yields have been in negative territory for over two years, German 10-year yields are finally crossing into positive territory. There is anecdotal evidence of the first signs of stress in certain equity pockets, in particular the ones where the post-pandemic investor darlings are concentrated. Amazon, a $1.7tn market-cap giant, traded like a smaller cap last week, down 7% before the results and then 14% up in pre-market the following day, after surprising to the upside; Snap was down 24% following Facebook’s disappointment, only to trade 50% higher one day later after recording its first quarterly profit ever. Although much can be rationalised after the fact, wilder swings tend to be a sign of lack of liquidity, as much as the pumping in of liquidity on the other hand provides market stability and a floor to risk assets. In credit we are nowhere near expecting similar dislocations, although spreads widening should gradually continue, as pension funds and insurance companies can start to find better yields in the no-longer-so-negative pool of global treasuries, hence providing less incremental liquidity to the asset class.

In FX the effects of tightening are felt in relative country terms, with more being already priced in in the United States, and a lot yet to be discounted for instance in Europe. With President Lagarde not ruling out the possibility of a hike this year, traders last week scrambled to reassess the monetary policy differential, gradually shifting in favour of the euro as the odds of incremental tightening in the common area increase. With a similar process taking place across the major countries joining in to remove policy accommodation, the dollar should stop being in the ascendancy and start to stabilise, to eventually reverse course. As long as global growth remains strong, a big if nowadays amidst tightening happening during a slowdown, a stable-to-weaker dollar should support investment flows directed towards non-US assets. In the absence of growth scares EM bonds and stocks should benefit, with American exceptionalism slowly fading.

Today’s greatest uncertainty lies with the ability of central banks to avoid negative impacts on growth as they normalise policy. Although not like-for-like comparable, last year’s aggressive stance of the Chinese authorities in the end affected the business cycle, causing a contraction in the real estate sector which forced a U-turn followed by renewed easing. Once the Fed has completed the tapering of asset purchases and hiked rates in March, we should be better able to gauge whether Powell will eventually be forced to follow in China’s tracks, or rather be in the position to continue with the greatest tightening in history.

Fixed Income Update

Another volatile week for the investors came to an end. The US Treasury yield curve from 2-year till 30-year increased by 13-15 bps post the strong January jobs numbers. The markets are currently pricing in 5.3 rate hikes by the end of this year. At the same time, the terminal rate assumptions have again crossed 2% according to the Dec 2024 Euro-Dollar futures. This time the rise in the yields could be stickier as G-10 central banks have either signaled rate hikes or have not explicitly ruled them out. The last rate-hike round in 2018 fizzled out when low global yields anchored the US Treasury yields due to the yield differential, making them more attractive than other developed market treasuries. We don't expect the Fed to surprise the markets with a 50-bps increase in March, as they have typically avoided such shenanigans in the past.

Credit spreads have widened since the start of the year to multi-year highs. Most of the Fixed Income segments have been battered by the double whammy of increasing yields and widening spreads as the market tries to digest the uncertainty. The average returns of different segments range between -2% to -3.5%, with China's local currency IG being the only exception with a +1.1% return YTD. We are carefully watching the spreads and would change our recommendations if they cross the seventy-five percentile range in the last five years, translating to 465 bps for Global HY and 180 bps for GCC Debt.

An interesting study by Goldman Sachs presents the difference between USD IG/HY indices and S&P 500 to understand the muted drawdown of the credit indices compared to the flagship equity index. While financials, utilities, Oil & Gas, and Telecom account for roughly 51% and 37% of the IG and HY indices, respectively, their share in the S&P 500 is low at 20%. By contrast, long duration and concentrated Technology sector accounts for 27% of the S&P 500 vs. only 10% and 6% of the IG and HY indices. So the credit indices are closer to the value "equity" proxy and hence the resilience. Further, unlike equity indices which are prone to high concentrations on Mega cap stocks, credit indices have a natural pull-to-par constraint that makes it difficult for a particular issuer to have a disproportionately large weight.

Closer home, the issuance scene is warming up with mandates of Sukuk issuance from DIB and Riyadh Bank Limited announced today. Last week, Fitch-rated PIF, the Saudi Sovereign wealth fund at "A," paving the way for an inaugural ESG bond issuance. ADNOC has completed its roadshows for inaugural multi-tranche bond issuance. February would be an exciting period for new issuance after a dull second half in January.

Equity Update

Global equities closed the week up almost 2%. Both developed and emerging market equities rallied, but not all markets were up. US equity indices gained, but not Europe. China was closed for the lunar day holiday, while Hong Kong markets opened up over 3% on Friday. India had a positive week, and GCC equities were slightly down. Government yields rose across US and Europe, yet equities largely had a good week as markets are taking inflation more in stride and earnings are supportive. Equity markets set rate hike worries aside last week, ignoring the pickup in yields and welcoming supportive growth. The U.S. earnings season was strong, with the 5 large tech stocks largely surprising and rallying, except for Meta Platforms. Europe finished lower, following monetary policy decisions from the ECB and the Bank of England. The ECB President sounded a hawkish tone regarding inflation, and expectations rose that the ECB could begin its rate hike campaign sooner than expected. The BoE hiked its benchmark interest rate by 25 bps for a second-straight meeting, Geopolitical tensions between Russia and Ukraine also remain in focus, alongside the possible impact on energy supplies to Europe. Both Brent and WTI are trading above $90/barrel and the energy sector continues to gain in synch. Expectations for the virus to be treated as an endemic globally are rising, and this should boost airline and travel companies and further improve mobility indicators.

Global equities are down 4.6% year to date after a very volatile January and a supportive start in February. Inflation has surprised to the upside, central banks are pivoting hawkishly, yields are rising, a record amount of stimulus is about to be withdrawn from the economy, yet in the first few trading days of February equities rose, getting support from good earnings and inflows. This is however only the beginning of the removal of stimulus and we expect that lower liquidity will continue to create volatile swings in markets, providing buying opportunities.

The markets have seen some wild swings amid diverging earnings results from some of the largest U.S. companies adding to the volatility driven by tightening expectations. Earnings remain supportive, Q4 earnings season has over 50% of S&P 500 companies reporting results and y/y revenue growth is up nearly 16% and earnings about 27%. E-commerce and cloud leader Amazon, as well as Snap and Pinterest, beat estimates and rallied, but Ford missed quarterly estimates and Meta Platforms disappointed with market share moving to Tok-tok. Amazon spoke of gains from its investment in Rivian Automotive, its biggest-ever Black Friday to Cyber Monday holiday shopping weekend, Prime Video's strongest viewership for live sports globally, and its AWS cloud-computing division, which announced significant customer momentum. The market liked the increase in the price of a Prime membership in the U.S., with the annual membership from $119 to $139, marking the first time it raised the price since 2018. This highlights the growing use of cloud, streaming, logistics and ecommerce. However, we need to remain cognizant of the increasing competition in these fields, with leaders such as Netflix losing market share and the overlap between the big tech companies.

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