“Absent recession or an unexpected moderation in inflation, the Fed is likely to maintain a hawkish bias.”

Macro

With risk of a full-blown financial crisis receding, focus is shifting to the ability of the economy to navigate the aftershock of the March bank turmoil. In contrast to recession concerns, US April preliminary manufacturing and services PMIs both surprised to the upside at 50.4 and 53.7 respectively, increasing for the 4th consecutive month and standing at the highest levels year to date. This indicates the current business cycle can withstand the unexpected dose of tightening that was added in March. That core PCE measures remained firm at +0.3% month-on-month, 4.6% year-on-year, 1Q23 +4.9% quarter-on-quarter, also leans in the direction of additional concern for the Federal Reserve. Remarks by various Fed officials reiterated the commitment to fight inflation and the need to tighten the policy stance a touch more. Given these developments, continue to expect a 25bp hike at the May FOMC meeting followed by an extended pause.

PMIs In Post COVID Recovery

Source: Bloomberg Finance L.P.

US debt ceiling concerns are a potential source of volatility. Projections were that the US Treasury could make scheduled payments without a debt limit increase until August, but with income tax receipts tracking below 2022 levels currently, there is an increasing probability that the deadline for resolution is reached earlier than projected. Base case is that the debt limit will be raised ahead of the deadline, as it has been in the past. Downside risks in the event of any debt ceiling scare are more likely to present as a temporary shock to US growth expectations, as non-interest payments would stop if a deal is not reached in time, rather than as fears of actual default. Should such an event occur, this could trigger sharp widening in credit spreads, even though any shock may be short-lived.

In China, 1Q23 GDP growth came in at 4.5% year-on-year, beating expectations of 4.0%. A range of factors contributed to the strong recovery in activity, including reopening driving travel-related consumption and services activity, front-loaded government support that lifted high-tech manufacturing investment, solar battery production and EV production, value of home sales value bottoming, and exports growing significantly in March. The big surprise in the April PMI survey – Manufacturing fell back to contraction – increases the case for more fiscal and monetary support. Expect the reopening bounce to continue into 2Q with most upside for consumer sectors, as travel and tourism have further potential to recover, especially going into the Labour Day holidays.

Fixed Income Strategy

Yield spikes, particularly at longer maturities, are likely to be capped in the near term as the Fed nears a pause in the hiking cycle and uncertainties relating to the debt ceiling could move into focus in the coming weeks. Absent recession or an unexpected moderation in inflation, the Fed is likely to maintain a hawkish bias and the market underestimates the risk that a midyear pause may not represent the terminal rate for the cycle, relatively pressuring shorter maturities. With the market pricing ~50 bp rate cuts over the next 12 months, reduce positioning in the front end.

Bank credit spreads partially recovered the widening in March. Within the sector, pockets of reasonably attractive risk-reward stand out. First, across the curve, short-dated bonds have lagged longer-dated bonds. Second, European GSIBs continue to trade at a discount vs. US money center banks. Increase positions in short-dated US money center and European GSIB seniors, especially given improving secondary market liquidity conditions. Third, risk premium on AT1 bonds remain high as investors continue to demand a high compensation for extension risk. Selected AT1s with near term callable dates and high reset spreads that are pricing in extension beyond the first call date screen as having better risk-reward profiles.

We continue to maintain position in Macau gaming operators. Sequential improvements continue with April data indicating average daily gross gaming revenue at 70% of pre-COVID level, up from 65% during 1Q23. Some 1Q23 operator earnings released to date, which indicated revenue recovery from mass gaming and retail income, providing a positive read-across for the sector. One caveat was that room inventory was constrained by labour shortages with only 2/3rd being available. Expect that when the labour situation is alleviated over time, this provides further headroom to grow gaming revenue. If and when the sector sells off, that presents an opportunity to increase positions.

Equities Strategies

As it is, traders are pricing in 2 rate cuts by this year end after a 25bps hike this week while the Fed remains cautious to end rate hikes prematurely. Amid these contradicting stances, we prefer to position defensively for the likelihood of different outcomes. Thus, we continue to be advocates of defensive sectors in US equities, ie. consumer staples and healthcare and concurrently seek opportunities to implement shorter-term tactical/swing trades through accumulating or buying quality, high beta US names such as blue-chip technology stocks as investors sector rotate into higher beta names in view of a potential end to rate hikes.

For HK/China, we continue to remain overweight in beneficiaries of the China reopening theme; 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 to support the domestic economy.

As the Fed meeting draws closer, we prefer to hold a reasonable level of cash, at least 10%-15%, selectively taking profit on tactical positions while keeping high conviction longer term core positions intact.