“The June inflation data suggests the path towards a “soft landing” is slightly more likely”

Fixed Income Macro

In June, US inflation fell to the lowest in more than two years, suggesting that the rate cycle may be at a turning point. Year-on-year, headline CPI eased year-on-year to 3% from 4% and core to 4.8% from 5.3%. Month-on-month, both measures climbed 0.2%, 0.1 ppt below forecasts. Meanwhile, resilience in the labour market and services sectors continues. Although nonfarm payrolls data was below expectations, coming in at 209k as last month’s tally was revised down from 339k to 306k, average hourly earnings were revised higher from 0.3% to 0.4%. The ISM services increased to 53.9, beating expectations of 51.2, as business activity surged to the highest levels since January. This backdrop is unlikely to prevent the Fed hiking an additional 25 bp at the upcoming FOMC meeting.

For credit, the near-term environment will be moderately supportive overall, as the recent data suggests the path towards a “soft landing” is slightly more likely and the bar to a “hawkish shock” looks quite high. Credit spreads continue to trade at the tighter end of the range. The Bloomberg Asia USD Credit spread is 256 bp currently, vs year-to-date and 12-month averages of 279 bp and 313 bp respectively. This can be attributed to 1H23 gross new issuance of Asia USD bonds falling 42% year-on-year to $62 billion, the reduced supply offsetting outflows from EM and Asia hard currency bond funds.

In China, since June a series of policy easing measures have been announced to stabilize growth, including tax and fee reduction/deferral for the corporate sector, modest interest rate reduction and targeted liquidity support for SMEs and rural area development by the PBOC, accelerated pace of special local government bond issuance. Further stimulus measures could be rolled out during 2H23, including further interest rate cuts and nationwide housing policy relaxation. So far, lack of sustained recovery in new home sales may require more than city-specific measures to support housing transactions, encourage land purchase and new home starts, especially from private developers.

Fixed Income Strategy

Markets are now about fully priced for a hike later this month, as well as roughly a 15% chance of another hike by November. Bond yields are currently near levels which persisted for short periods in October 2022 and March 2023. The June inflation data suggests the path towards a “soft landing” is slightly more likely. It appears that disinflationary data could become more prominent in 2H23 and further cooling in labour markets over coming months should allow the FOMC to go on an extended pause after this month. The debate will then turn to their next meeting in September, although it is unlikely for the Fed to start cutting until well into next year. Taken together, further extend rates duration of bond portfolios.

One driver for tight credit spreads has been postponement of US recession risk, inducing investors to abandon recession trades such as underweighting riskier issuers. The compression in high yield spreads is consistent with unwinding of recession trades, despite specific concerns around the HY refinancing wall. Most investment grade issuers are well positioned to cope with the risks, particularly those owned by governments, whose intrinsic support provides some buffer against disruption in financing access. For high yield corporates, the rise in downgrades year-on-year, including downgrade reviews by ratings agencies, potentially indicates a nascent credit cycle downturn. We are in the view of maintaining up in quality positioning.

We are in the view of trimming China property high yield positions. Recent months have seen property sales momentum stall, mortgage growth flatline, and notable increase in bond defaults. Since April, three more issuers have missed coupon and/or principal payments on their offshore bonds. Policy easing towards the sector continues to focus on ensuring project completions, with the industry experiencing sluggish demand from home purchasers and shrinking gross margins. Unless policymakers can restore confidence and provide additional financing support for developers, the sector default rate is tilted higher.

China Home Sales by Top Developers Decline Again

Source: Bloomberg Finance L.P.

Equities Strategies

We continue to maintain our view that the probability of any rate cut this year is low as key macro data such as a 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 extremely overbought AI related plays. In addition, we are also inclined to have positions 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 2H’23.

For HK/China, we continue to remain overweight in beneficiaries of the China reopening theme despite the slower-than-anticipated “reopening” thus far on hopes of potential stimulus from Chinese government in 2H’23 and attractive valuations. We favour Chinese airlines, domestic consumption-related, travel-related and F&B-related sectors. We are also skewed towards infrastructure-related names in view of an accommodative policy stance. These sectors are still trading at attractive valuations and deserve our attention 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 and valuation upside.

Last but not least, we recommend portfolios to remain nimble and defensive through holding higher cash levels or increase hedging.