Weekly view - Debt Ceiling Reached

Last week saw the US hit its debt ceiling, with future negotiations to increase the statutory borrowing limit sure to be highly problematic. Further signs of a rapidly slowing US economy also emerged, with retail sales declining for the second month in a row in December. Figures showing a weakening in industrial production and lower capacity utilisation in December also increase the probability of recession and helped bring the 10-year US Treasury yield below 3.5% last week. Meanwhile, large US banks and tech names have been announcing substantial layoffs. As companies miss revenue targets, operational leverage has turned negative, notably in consumer stocks. Some large consumer-staples companies have reported reduced sales for the first time in five years, consumer discretionary companies have been cutting their profit forecasts and high-profile communications-services companies have barely made their earnings-per-shares targets. Despite a late comeback, all this meant that the strong start to 2023 for equities stalled last week. This week will see more quarterly earnings releases from Big Tech as we stick to our belief that 2023 will see a convergence of equity risk premia between the US and the rest of the world.

With the German producer price index declining less than expected in December, and with the drift downward in consumer prices as well as capital goods lagging the drop in energy prices, the hawkish message delivered last week by European Central Bank (ECB) president Christine Lagarde would seem justified—all the more so as it seems Europe may avoid recession. Fiscal support, the decline in energy prices, and elevated gas inventories point to a turnaround in Europe’s prospects. Consequently, European bond yields and the euro rose last week. We see US Treasury and European bond yields continuing to converge and remain negative euro periphery bonds.

After its surprise December decision to relax the cap on the 10-year Japanese bond yield, the Bank of Japan (BoJ) left policy unchanged last week. We think further changes are unlikely before Haruhiko Kuroda steps down as BoJ governor in April, but his successor could move toward further policy flexibility. In short, we expect the BoJ to reassess its monetary policy when market pressure has abated and remain positive on the Japanese yen over the medium term. In China, we think the surge in holiday travel for the Luna New Year could present a fresh covid challenge. Households’ spending of the forced savings accumulated during ‘zero covid’ is seen a major contributor to growth this year. Indeed, consumer spending and confidence will be key to the reinvigoration of the Chinese economy. In particular, all eyes will be on home prices and activity given that the property sector accounts for some 25% of the economy. We also expect China’s rebound to put upward pressure on energy prices. With that in mind, we wish our readers a very Happy Year of the Rabbit!