Yields and oil continue to move higher hurting equities

Market movers today

UK releases CPI, where consensus looks for the monthly figure to drop to 0.3% in December from 0.7% in November. Core inflation is expected to drop to 3.9% y/y from 4.0% y/y.

US releases housing starts and permits. The housing market is hot at the moment with low inventories and big price increases. However, following strong readings in November both starts and permits are expected to drop for December.

Wednesday night China will announce the Loan Prime Rates (LPR), (both 1-year and 5-year, which we expect to decline 10bp following the 10bp cut in the Medium Lending Facility on Monday. The LPR is based on bank reference rates, which are linked to the MLF rate.

The 60 second overview

Macro: The New York Empire State Manufacturing index nose-dived in January falling to -0.7% from 31.9 in December. These smaller regional indices are often quite volatile, but given the size of the drop there is a clear indication that in the wake of supply problems, Omicron restrictions and people off work due to illness or quarantine, manufacturing has come off 2022 on a weak footing. That said sub-indices such as future prices were strong. The market will closely scrutinize the Philly Fed index tomorrow to see if the weakness is repeated.   

Yields: US 10Y treasury yields continue to move higher and reached 1.88% over night - the highest level since late 2019. The move this year of 27bp has been the fast monthly increase for six years, The market continues to boost expectations for US monetary tightening and the market is now pricing in four rate hikes of 25bp this year and 2 and a half rate hike next year. The market is pricing a good probability that we will see more than two rate hikes in H1 2022 or alternatively a 50bp hike.

It is our view that the first year of the US money market curve is now fair priced especially as we expect the Fed to reduce the balance sheet (QT) in Q3 this year. Yields are moving higher with stable to lower US inflation expectations (break-evens). It has resulted in a sharp move higher in 10Y US real rates that after trading around -1% for the last six months is now trading 40bp higher at -0.6%. The latter is one important factor behind the current poor risk appetite in many markets. We forecast that the market is still understating the number of Fed rate hikes in 2023 and that 10Y US treasuries will hit 2.25% in 2022 partly driven by another move higher in real rates as QT kicks in. For more see Fed research: End of money printing brrrr - (at least) four 25bp rate hikes this year and QT in September published yesterday. 10Y Bund yields trade at -2bp and it seems just a matter of time before that moves into positive territory and 10Y UST yields hit 2%.      

Oil: Despite the poor risk sentiment in many risk markets oil continues to climb with Brent hitting USD 88.5 per barrel over night. Demand expectations are improving as the Omicron variant is seen paving the way for a boost in travelling later this year. But as many other commodity markets the oil market is also hit by supply concerns and dwindling spare capacity. In light of the pandemic and the green agenda oil investments have been depressed for the last two years and the market is increasingly worried that the OPEC buffer will fall further leaving the market vulnerable for higher prices if any supply disruptions hit the market. Oil hitting USD 100 a barrel again no longer seems farfetched. 

Equities: Equities were lower across the board on Tuesday with a strong tone of stagflation hitting the markets. Energy sector outperforming, higher bond yields and a macro report (Empire Fed) showing a huge drop in order and shipments but still high price pressure. This bad combo triggering a move towards value defensive, min vol and large cap. Of course not benign for investors but very much in line with our strategy. Put on top of this rising Russia Ukraine tensions, sending Eastern European stocks down almost 5%. US reopening after holiday Monday with Dow -1.5%, S&P 500 -1.8%, Nasdaq -2.6% and Russell 2000 -3.1%. No signs of sentiment improving this morning with Asian stocks lower led by Japan. US and European futures in red as well.

FI: Yields continue to rise as the markets are boosting expectations for earlier and more rate hikes by the Federal Reserve. The higher oil price is also boosting expectations for a faster move by the global central banks.

FX: The combination of surging yields, resilient commodity prices, earnings misses among banks and weaker-than-expected US soft industrial figures have made for an interesting cocktail in FX markets. So far the clear winners have been the USD and the JPY while the risk-sensitive currencies in EM and Scandies have suffered considerably. EUR/USD is now back close to 1.13, EUR/SEK has moved to the mid 10.30s while EUR/NOK keeps hovering just below the 10.00-figure.

Credit: Very bad sentiment for risk assets yesterday due to rising rates. iTraxx main widened 0.9bp to 53.6bp. Xover widened 4.7bp to 259.2bp. Yesterday marked the fifth day in a row with widening cash spreads with IG wider by 1.3bp and HY wider by 5.7bp.