Weekly Investment View: Long USD/CNH, Bearish Bonds

This Week 

Bilal discusses the recent bond selloff and why we remain bearish rates; Dominique previews the US small business survey and CPI; John likes to tactically overweight the consumer staples sector; Caroline discusses Sunday’s consequential election in Poland; Mirza and Liang initiate a long USD/CNH; Henry thinks we may get dovish details in the final EZ inflation prints this week; Viresh argues the oil price depends on Iran’s possible involvement in the Israel-Hamas conflict. 

Bilal Hafeez – Global Macro 

The big question after the recent bond selloff was whether the Fed would view it as a tightening of financial conditions (and hence less need to tighten policy) or just rates normalizing. Monday’s comments by Fed officials suggest they are in the former camp. Logan (hawk) and Jefferson (modest hawk) both indicated that financial conditions have tightened. Bonds have responded, with the 10Y yield down 15bps.  

Yet notably, previous large surges in US bond yields have often seen corrections. The past three-month jump has been a two standard deviation event. Since 2000, bond yields have typically fallen around 14bps after such a move. Given we have already seen a 15bps drop, this suggests caution in extrapolating a decline in yields. 

Moreover, stocks and credit have rallied after the bond rally, implying financial conditions may start to loosen. This is the circularity of the Fed focusing on bond yields and equities.  For now, we remain bearish bonds and bullish the dollar. This week’s US CPI data matters as it could disrupt the goldilocks narrative (strong growth, low inflation). 

Dominique Dwor-Frecaut – US Macro 

This week, I focus on the small business survey and CPI. In the first, I expect trends to persist: rising intentions to increase prices and wages as well as an uptrend in the hard components of the optimism index. 

I expect the CPI to show August’s broadening inflationary pressures continuing (see US CPI Review – Broad-Based Acceleration). We could be near a trough on OER inflation. The ongoing slowdown goes against the pre-pandemic trend of faster OER inflation than other services – a trend that reflects underinvestment in housing since the GFC, especially single-family homes (SFH).   

The ongoing slowdown in OER costs could reflect a recent surge in multi-family home construction. That surge seems over due to higher interest rates as well as Americans’ preference for SFH, where 70% of them live. 

John Tierney – US Equities 

Another robust labour market report should lay to rest concerns about the economy for now. Equities seem to be settling into a new range as the 10Y Treasury yield trades between 4.6% and 4.8%. We think the market is pricing in a view that the Fed could raise rates to 6% then hold. 

In coming days, renewed conflict in the Middle East could lead to volatility, especially if oil supply and price are affected. But we expect this will soon settle. For perspective, in the month after Russia invaded Ukraine, the S&P 500 dropped 4% then recovered. 

Earnings season opens this week with major reports from PepsiCo (PEP) on Tuesday and bulge-bracket banks on Friday. We think the selloff in consumer staples, especially companies like PEP and Cola-Cola on diet drug concerns, is overdone. We suggest a tactical overweight in the consumer staples ETF XLP, and in PepsiCo (PEP) and Coca-Cola (KO). 

Caroline Grady – Emerging Markets 

In Poland, opinion polls remain inconclusive ahead of Sunday’s general election. Performance of the three smaller parties will be crucial for the distribution of seats in the 460-member Sejm and for coalition dynamics for either a PiS or KO-led government. Should Third Way Alliance not meet the 8% threshold to enter parliament on a joint list (Polska 2050 and PSL), this would automatically benefit PiS. 

An opposition-led centrist coalition is the most market friendly outcome as it would see improved relations with the EU and Ukraine, restoration of the independence of Polish institutions and probably more predictable economic policy. A PiS-Confederation coalition is the least market friendly outcome. 

Mirza Baig / Liang Ding – Emerging Markets 

After returning from week-long holiday, the PBoC has kept the USD/CNY fix steady, and Bloomberg has reported that authorities are considering issuing an additional $137bn (0.8% GDP) bond issuance in Q4 for infrastructure investment. RMB strengthened a little on this, with offshore USD/CNH spot converging to onshore USD/CNY.  

We are focusing on two indicators that suggest PBoC may be more willing to let the daily fixings rise. Specifically, bond yield differential suggests spot fair value is around 7.40. And the CFETS basket has recovered to pre-summer levels. As such, we are initiating long USD/CNH via 3m forwards at 7.2570 (spot ref 7.2850), with a stop at 7.15 and target 7.500.  

We are mindful of the consensus nature of this trade. Sentiment towards China is already quite bearish. Thus, a material improvement in fundamentals could lead to a sharp price reversal. There are two potential catalysts for this: a Xi-Biden summit and a credible economic plan presented at the Third Plenum (no date announced yet). 

Henry Occleston – Eurozone & UK Macro 

Wednesday sees Germany’s final read for September inflation. On Friday, we get France and Spain’s. The preliminary core EZ aggregate inflation print was undeniably dovish (core at +4.5% YoY, vs consensus +4.8%), representing an undershoot in MoM versus a typical September. The preliminary readings showed several other important elements: 

• German core inflation at +0.1% MoM – lower than in 2022 and 2021, but higher than typical. 
• German services at -0.1% MoM, decently stronger than a typical September (given discounting usually seen). 
• Much weaker French seasonal-adjusted manufacturing goods prices than typical (+0.8% MoM). 

• Decently more discounting seen in French services than typical for a September (1.6% MoM). 

We will examine the final prints to see if the details are dovish – in particular, whether more volatile, seasonal elements may have softened inflation, and whether wage-intensive services inflation remains relatively strong (Chart 7). 

Last week’s services PMIs suggest wage pressures remain strong, and September saw firms increasingly passing on these costs to customers. We think wage-intensive services inflation will have stabilised or bounced back in September versus the August dip. 

Viresh Kanabar – Commodities 

Brent spiked to around $87 on Monday as markets digested weekend events in Israel. Historically, Israel-Palestinian conflicts (2000, 2008, 2012, 2014, and 2021) have had a limited near-term impact on oil prices. However, broader risks here make this time slightly different. The risk to oil prices stems from two areas: 

1. Iran supply risk. A WSJ article yesterday suggested Iran may have been deeply involved in supporting the attack – if US intelligence backs this up, it instantly puts barrels at risk via greater enforcement of sanctions – like 2019 onwards (recall Secretary Blinken stated over the weekend that they are unaware of Iranian involvement). Specifically, certain trade routes that transfer Iranian oil into Syria past the shores of Israel, or entering the Red Sea from the South, are likely be off limits now, which means longer shipping routes. 

2. Wider conflict draws other territories. There are lot of unknowns right now, but broader conflict that draws in other nations and their proxies would increase the geopolitical risk premium added to the oil price. 

The near-term trajectory for oil mostly depends on the first point. Watching US communications around Iran will be key. If further messaging absolving Iran is released, immediate-term price pressures could tilt to the downside. 

Most of Iran’s oil exports were to China (around 1.4mn b/d), so seeing China start competing for barrels in the market would indicate Iranian flows may be impacted, or that China wants to make purchases just in case. Both add upside to the oil price. 

Finally, we expect the EIA data to show a bounce-back in gasoline demand this week and next. If our theory that fuel stations decided to hold up purchases of gasoline as crack spreads fell sharply is correct, we should see a rebound in product supplied. This will help reverse some of the negative demand-related sentiment in the market. 

(The commentary contained in the above article does not constitute an offer, a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)