“As indicated by key macro data, rate cut this year remains low”
Fixed Income Macro
Interest rates declined sharply over the past 2 weeks – the benchmark 10-year US Treasury yield, which was only 6 bp below its year-to-date high as of end-October is now 30 bp lower. The move lower was aided by a trio of factors. First, a smaller-than-expected Treasury refunding announcement, with firm guidance to expect one more round of increases in February, before issuance sizes stabilize into mid-2024. Second, an FOMC meeting which appeared less hawkish than anticipated. Third, macro data have finally begun to show signs of cooling – both ISM and labour market data are surprising to the downside. With the recent price action, risks on bonds are now tilted more bearish given the alleviation of oversold conditions, forward pricing of policy rates, and near-term supply dynamics.
In credit, a quiet and rangebound market quickly changed after the FOMC meeting was perceived as dovish. This in turn boosted sentiment, with the Bloomberg Asia USD Credit spread tightening 24 bp over the past two weeks. On fundamentals, 3Q earnings season is nearly complete, and results are generally decent enough from a credit perspective. This is translating into ratings trends where credit rating upgrades are outpacing downgrades. Issuer buyback activity is also contributing positive price action, which for issuers that have access to liquidity and whose bonds are trading at significant discounts, supports profitability through gains on extinguishment of debt. On technicals, outflows appear starting to moderate slightly with EM hard currency bond fund redemptions at $0.9 billion month to date vs $5.1 billion in October.
In China, headline CPI slipped into deflation for the second time this year, falling a slightly deeper than forecast 0.2% year-on-year in October. October core CPI printed at 0.6% year-on-year, down 0.1% month-on-month, the first sequential decline in 8 months. October PPI remained in deflation mode, falling 2.6% year-on-year vs -2.5% year-on-year in September. The recent fiscal policy to increase this year’s fiscal deficit by RMB 1 trillion, funded by special central government bond issuance, will support infrastructure investment through to early 2024. However, continued policy focus on investment and production is intensifying economic imbalances, with sluggish consumer demand as suggested by core CPI. Domestic deflationary concerns, especially on consumption may continue, if stepped-up policy support to households continues to be absent. Meanwhile, the downtrend of PPI may further contribute to global goods disinflation.
Fixed Income Strategies
DM central banks have been aligned in delivering the dovish pushback against further rate hikes, while still generally retaining a tightening bias and agreeing that it is too early to discuss the start of new rate cuts. Yet markets are currently pricing that the Fed will cut rates for the first time in June and will have implemented almost 80 bp of reductions by end-2024. A similar amount of cuts is priced from the ECB, potentially starting as soon as April. In the UK, the BOE is seen reducing the benchmark rate by almost 70 bp. Mitigating the risk that rate tightening cycles are not over is elevated yields which offer meaningful cash flow vs any renewed selloffs. Looking ahead, it is likely there could be some further room for the rally to extend as investors search their way to the bottom end of the new range, particularly if supported by softer economic data, but expect the yield floor of this range is materially higher than when the selloff began during 3Q23. Should the easing priced extend much further, we are inclined to trim duration of bond portfolios.
Market Prices Core Policy Rate Cuts Within a Year
Source: Bloomberg Finance L.P.
Most HG credit demand is yield driven, not spread driven, and thus a further drop in yield is less positive. The effect of lower yields is higher issuance near term, which, coming against a backdrop of fund outflows, could lead HG spreads to trade sideways to a little wider. That said, Asia USD bond supply year-to-date has been relatively muted, largely because most issuers can obtain onshore financing at less expensive levels. Asia issuers have sold $95 billion bonds for the first ten months of 2023. With about one month left before the primary market shuts down for year-end, full-year supply is likely to come in at ~$110 billion, 20% lower than $137 billion raised in 2022 and about one-third of the peak amount of >$300 billion raised in 2019-2021. The supply technical largely explains the resilience of Asia IG spreads from macro volatility this year and can continue to support spreads into year-end. Among sectors, technicals appear the least favourable for financials as they account for the largest share of total supply (~40% in 2023 YTD) and that is expected to continue in 2024. We are inclined to position in corporates that demonstrate access to onshore refinancing and/or potential for liability management exercises.
Macau October gross gaming revenue (GGR) increased 31% month-on-month to hit a post-pandemic high of MOP19.5 billion, reaching 76% of 2019’s level and implying a daily run-rate of MOP 650 million vs MOP 531 million in 3Q23. Beneath the surface, higher margin mass market GGR is running comfortably at 100% of pre-COVID levels vs 95% in 3Q23, while lower margin VIP GGR remains at around 25%, similar to recent months. For industry earnings to match 2019 levels, this requires mass market GGR to recover to 110-120% of 2019, which seems achievable given further infrastructure developments ahead, and with spillover effects from the removal of junket operators contributing to higher mass market GGR. Spreads have potential to tighten as most issuers are expected to turn cash flow positive in 2023 or 2024, deleveraging into 2024 would support stable credit rating outlooks, while a few such as Sands and Wynn may be upgraded as their parents benefit from Macau as well as improvements in Singapore for the former and Las Vegas for the latter. Despite the rally over the past two weeks, most bonds still offer 8%+ yields. We are inclined to increase positions in Macau gaming operators.
We continue to maintain our view that the probability of any rate cut this year is low as key macro data such as a slowdown in inflation, strong labour market and consumption are still holding up. Although we continue to favour large-cap and quality growth stocks in the US, it is important to be selective against a backdrop of overbought AI related plays. We recommend to buy the dip at more reasonable valuations in US technology sector, in particular the AI-related names should a pullback materialise, as well as in defensive and laggard sectors such as consumer staples and healthcare, which offers more attractive risk/reward should the US economy enters into a soft landing in 2024. Do consider staying focused on quality industry leaders with significant market share, robust balance sheet and reasonable earnings growth.
For HK/China, we remain cautious whether the 1trillion yuan stimulus is large enough to rebuild confidence and support a sustainable domestic recovery. Nevertheless, the Chinese government proactive stance and willingness in providing measures to support the domestic economy is assuring for investors and should provide near-term support for Greater China equities. Against this backdrop, we recommend investors to consider continued to accumulate on selected Equities exposure in HK/China in a staggered approach on significant market pullbacks. As concerns still linger on the effectiveness of this new round of stimulus package, we recommend investors to consider adding HK/China Equities exposure through Index ETFs rather than individual securities in order to mitigate market and P&L volatility.
Our preferred sectors are Technology, EV-related and Travel-related industries. We are also inclined towards infrastructure-related names in view of a potential accommodative policy stance. These sectors are trading at attractive valuations, be it from a longer-term fundamental perspective or that of a short-term swing trade. We also continue to be advocates of defensive sectors such as Telecoms and Utilities that provide reasonable dividend yields with decent valuation upside. While we continue to monitor key data points, in particular those that could lift the real economy, market sentiment and hence a rebound in Equities, we reiterate that portfolios should stay nimble and diversified. Overall Equities exposure should remain moderate to low as year-end looms with increasing geo-political tensions and as most of the concerns that plagued global Equities throughout the year still linger.
Finally, we recommend overall portfolios to remain nimble through tactical swing trades and consider the use of some structured products with downside protection.