Market Review 01/2023

Recent ECB and FOMC meetings hardly brought any surprises with market showing that it has priced in current (as well as a few next) increases in interest rates and believes that this hiking cycle would not be long. Officials, however, have repeatedly stated that the rates would remain high for a long time, only for participants to ignore these messages, just as they ignored early warnings of rate hikes. Overall, we tend to agree that bond yields “look toppish”, but still there is a notable risk of another yield rally before market turns. That is why we still are more comfortable with shorter term papers and are not rushing with buying longer-term maturities. We also believe that equity markets are very close to their resistance regions and have more chances to fall from current price levels rather than continuing January rally.

Optimism drives both equities and credit

So far, however, equities are enjoying their good days. In comparison to autumn, the future, it appears, doesn’t look so gloomy; interest rates, as the market is sure, will be reduced already at the end of this year, bringing them to acceptable levels of ~3% by the beginning of 2025. Such a scenario is favorable for risky assets and growth stocks especially, since periods of low rates force investors to look for companies with high growth prospects.

Debt markets also did not disappoint in this time of general optimism. Since the beginning of the year bond indices, starting with European sovereign and ending with speculative grade, have risen by 2-4.5%, recovering some of the last year’s losses. The rate of inflation has been declining in the US for five months in a row, and for two months in Europe. On the other hand, benchmark bond yields in the US have been falling for three months, while in Europe this process has only just begun. The current upbeat sentiment in financial markets is based on expectations that the worst is behind us and that a slowdown in inflation will allow central banks to complete their rate-hiking cycle sooner rather than later. This view is based on, at first glance, reverse logic, namely that in developed countries recession is “around the corner”, but it will be mild and, moreover, will force central banks to abandon further implementation of restrictive policies.

European and US equity markets

Meanwhile, central banks’ rhetoric and plans are to continue raising base rates at least in the next couple of meetings. Central bankers have long been famous for their pragmatic slowness in changing monetary course, so we think investors are being overly optimistic. The current dissonance between interest rates and bond yields cannot hold for long – one of the parties will have to make concessions.

Benchmark 10-year bond yields

Some interesting observations in alternative asset classes

EUR/USD kept on creeping higher in an attempt to test the long-term trend line drawn from now-distant 1980ies. There is a tendency for the dollar to set yearly highs or lows already in January, so, as we said a month ago, one must keep an eye on 1.0480 or 1.0950 for a directional clue. We still see the 1.1000 mark as a strong resistance and expect market to push the pair lower in coming weeks, though any monthly close above 1.1300 should be considered as an important long-term signal.

Precious metals had a mixed month – gold climbed higher, and is now approaching a XAU/USD 2000 mark, while silver rested on its previous gains. There is a risk that 2000-2050 area for the yellow metal will once again prove too difficult of a wall to climb in this attempt, while we believe that silver could indeed break past the 25 dollar per troy ounce resistance level.

Oil is still locked in a relatively narrow range, but broader picture looks positive for energy, although it is too hard to see how “price ceilings” and other restrictions will affect prices in long term.  Meanwhile, prices for natural gas have now fallen below pre-war levels and even below their average 30-year price line. Well, we “read” this as “cheap”, too, with question being – when the economy will embrace cheaper energy prices and when we see this reflecting in inflation figures.

High Yield bond Indexes

Europe surprises on the upside, US struggle

After posting a 0.1% growth in the last quarter of 2022, the Eurozone might once again escape a contraction in the first quarter of 2023 as business activity increased in January – S&P Global Composite PMI, which is seen as a good gauge of overall economic health, increased by one point to the reading of 50.3, which is a seven-month high. Block’s dominant services industry was back to growth as consumers drove up the demand despite cost of living crisis, and manufacturing activity was also improving with S&P Global final manufacturing PMI increasing to 48.8 (five-month high). On an annual basis, inflation decreased to 8.5% in January, down from 9.2%, according to Eurostat.

Lifting Covid-19 restrictions had a positive effect on China’s services as spending and traveling had an expected boost – the Caixin/S&P Global services PMI increased to 52.9 compared to 48.0 in December. Contrary to services, the country’s manufacturing activity in January contracted although at a slower pace than in the previous month. As a result, the Caixin/S&P’s composite PMI increased to 51.1 in January compared to 48.3 a month ago, marking the first expansion in five months.

Manufacturing activity in US contracted for the third month in a row as increase in interest rates curbed demand – the Institute for Supply Management’s manufacturing PMI decreased to 47.4 compared to 48.4 in December. Layoffs in the US reached a more than two-year high in January as technology firms cut jobs at the second-highest pace on record. Possible recession is also damaging consumers as their confidence decreased in January (and inflation expectations rose) – the Conference Board’s consumer confidence index decreased by almost two points to 107.1.

Gold price, USD/oz