Inflation in major economies remain severe, both the US and Europe figures are close to record highs. The US Fed sped up its tapering schedule in response, where the tapering of bond purchases will now be complete by March, the end of bond purchases opens up the opportunity for rate hikes. At the time of writing, rate futures markets expect 3 rate hikes from the Fed in 2022; meanwhile, treasury yields are also climbing higher, these would be problematic for the fixed income market if they do materialise.

Henceforth, ‘HY over IG’ will remain our core view on the fixed income market into 2022. We still expect the longer duration IG bonds to suffer more as global interest rates move higher over the year. In contrast, we still see opportunities in the high yield space. Global high yields should see further improvement with the continued pandemic exit, while remaining relatively unaffected by the rising rates due to their lower duration. Asian high yields in particular could offer a rare opportunity, as the anticipated loosening monetary environment in the Chinese market could potentially start the recovery in this badly hit market in 2022.
 

While COVID cases were still far below their previous peaks, the trend has been upwards, prompting the government to tighten restrictions over borders and local economic activities. If the latest wave of Omicron does manage to gain a foothold in the country, it could spell more restrictions for longer, inevitably impacting the economy. The travel ban in particular is hard on relevant sectors such as travel, retail, and hospitality related, dampening the Japanese economic outlook in the short term. 

Overall, outlook of the Japan equity market is affected by 2 aspects. On one hand, the economic fundamentals remain weaker, as suggested by the leading indicators. The headwinds from the renewed COVID crisis also do no favours to the 2022 economic outlook. However, this is still somewhat balanced out by the loose monetary policy, guaranteed by the low inflation which has diverged from the global trend. The dovish monetary policy could also potentially support equity valuation, while the weak local currency due to the widening yield cap could potentially supporting corporate earnings. Considering factors from both sides, we stay neutral on the Japan market for 2022. 
 

  US

The market is worried that the Fed will take a more aggressive path in hiking interest rates, leading to worsening sentiment and a sharp fall in the US stock market. The Dow was down 4.34%, the S&P 500 5.15% lower and the NASDAQ fell 6.81% over the past five days ending Thursday. The NASDAQ in particular is down by almost 10% this year. Earlier, William Ackman, a famous US hedge fund founder, said that the Fed should raise interest rates by 50 basis points at the March meeting, market is worried about a faster rate hike, which also increased selling pressure in the market. According to Bloomberg interest rate futures, the odds of the Fed raising rates by 25 basis points in March this year have risen to 100%. Although the market is not expecting a 50 basis points hike, but it is still pushing its rate hike expectations gradually higher.

Another event in the spotlight is the US earnings season. Goldman Sachs reported a 13% drop in earnings last quarter, which was weaker than expected and weighed on the banking sector. Of the 61 reporting companies, 77% reported earnings beats. 73% of the 26 financials that reported earnings were better than expected, while all six reporting technology companies managed to beat earnings forecasts, though the most important technology giants such as FAAMG have yet to report their results. It is worth mentioning that crude oil prices surged to a seven-year high, with WTI futures reaching a high of US$87.91 per barrel, before retreating to around US$83. The Organization of the Petroleum Exporting Countries (OPEC) said it expects the global crude oil market to be supported by strong demand this year. Next week, the US will release its interest rate meeting statement in the early hours of 27 January, and markets will be focusing on tapering details. The US will also release its GDP for 2021 Q4 in the evening of the same day.

Europe

While US stocks fell sharply, European stocks were not significantly dragged down, perhaps reflecting the market's confidence in the ECB to maintain its accommodative policy. Over the past five days ending Thursday, UK equities rose by 0.56%, French by 0.72% and German by 0.18%. The ECB released the minutes of its December meeting, which showed that policymakers suggest that inflation in the Eurozone may easily remain above the bank's target, so the central bank should keep its options open. Central Bank President Christine Lagarde said that inflation was expected to fall this year and that there were reasons not to follow the Fed's swift and vigorous response. Next week, the Eurozone will release its manufacturing PMI for January.

China

Hong Kong stocks reversed last year's weakness as the Hang Seng Index continued to rebound this year, gaining 2.39% this week and up 6.7% YTD, which is among the best globally. China A-shares also performed well, with the CSI 300 Index gaining 1.11% over the week. In the face of economic pressure, the People's Bank of China (PBoC) lowered its LPR rate by 5 basis points for 5 years or above and by 10 basis points for the 1 year rates, which is the first in more than a year and half. The PBoC said that the economy is now under three-pronged pressure, and more policies supporting stable growth will be introduced before the downward pressure eases. Next week, China will announce industrial profits for December last year.

Heading into the New Year, our EM outlook has remained largely unchanged, as the external environment is still challenging. The overarching pandemic situation could affect EM economies, as the discrepancy in vaccinations likely leads to divergent economic recovery. With lower vaccinations and less control over the pandemic, expect more and longer restrictions in the respective economies, outlook would likely be less positive than their DM counterparts. Weaker fundamentals as reflected by the EM economic indicators further support our bearish view.

Inflation is another drag factor. Global monetary policies are starting to tighten in response, with a stronger Dollar due to rising yields. This do not bode well for EM equities, as a strong Dollar tends to impact EM equity performance. Moreover, EM central banks have already hiked rates over the year to deal with their own inflation, but these could damage the local economy, as tightening monetary conditions tends to hinder economic recovery. With these macro backdrop factors not dissipating anytime soon, we maintain our conservative view on EM equities in 2022, only staying selectively opportunistic on China which is covered in the other section, and certain Southeast Asia markets which have better pandemic control and are facing less inflationary pressure. 

While the economic data remained positive, the fundamentals are weaker than the US, which dims it outlook as the speed of economic recovery is poised to slow down in 2022. More importantly, inflation remains as an unresolved issue, with the latest CPI figure hitting a new record high again. That said, the ECB was one of the few central bank that have kept their stance unchanged despite rising inflation. The latest figure has retreating in MoM terms could suggest that the peak inflation might have been behind us as suggested by ECB President Lagarde, posing less of a problem. 

The new Omicron variant has become the dominant COVID strain in most countries. While preliminary reports have shown that while this new strain is more infectious, symptoms are seemingly milder, and contracting this strain could offer better protection against previous variants, which is positive for the economic outlook. Even though several European governments have re-imposing certain restrictions, a majority of them are targeting the unvaccinated, henceforth limiting the impact to the overall economy. Expect the European outlook in 2022 to remain modestly positive, weaker economic momentum is balanced out by the supportive monetary policy, while easing pandemic fears should also reduce the downward pressure on the equity market.

Indicators for major industries show a continued slip in the YoY figures, supporting the view that Chinese fundamentals are weaker. The real estate sector continues to be the biggest detractor for the economy, more Chinese developers are waiting for financing conditions to improve to avoid default. According to statements from the authority, ‘stability’ have returned as the policy priority, where the numerous credit events in 2021 was not the intended result. Therefore, if policy pressures shall ease as we expect, the Chinese economy, and especially the hard hit sector, should see better recovery.

Similarly, the tech sector has also experienced much pressure throughout the latter part of 2021. Although regulatory actions impacted the tech space business outlook, we think this trend could change in the New Year. Referencing past regulatory cycles, the tech regulatory cycle could be nearing its end. Signals coming out from the Chinese authorities have also brought hope that there will more regulatory loosening in 2022. With the pandemic likely under control, and anticipating fiscal, monetary, and regulatory loosening, we are positive on the Chinese market in 2022.

At the time of writing, Omicron is the dominant strain in the US, helped by its high transmissibility which exceeds that of the Delta variant. The good news is early data from South Africa showed limited impact on the healthcare system, which was supportive of global financial markets, as it ensures limited disruption to the economy with no lockdowns and restrictions imposed. In the New Year, we expect the global economic recovery to slow down, as the low base effect fades out in 2021, but the economic growth should still remain above the long term trend.

With inflation remaining at an elevated level, rates are expected to go higher, with the Fed expressing desire to tighten monetary policy to rein in inflation. There are opinions that the rise in rates could impact growth sectors disproportionally, but long term rates have actually stayed relatively stable, the volatility in the sector is more likely due to profit taking rather than an actual impact on the company prospects. Looking forward, we are still positive on the US equity market, and expect growth stocks to outperform amid slower economic growth.

  US

The US inflation rate hit a near 40-year high and the hawkish comments by Federal Reserve Chairman Jerome Powell have heightened market concerns about accelerating interest rate hikes. Uncertainty has weighed on US stocks, with the S&P and Dow down 0.79% and 0.34% respectively over the past five days ending Thursday. The US CPI rose 7% YoY in December last year, the highest jump in 39 years. This has increased market expectations for a rate hike in March, with the probability of a rate hike in March rising to 90%, according to Bloomberg interest rate futures data. Earlier, Chairman Powell said that in order to curb the worsening inflation, the Fed could raise interest rates more often if necessary, and that the tapering would be carried out faster and earlier than it did in previous cycles.

On the pandemic front, studies have shown that T-cells produced after a common cold can also fight off the coronavirus. Despite this, the spread of the new Omicron variant continues to accelerate. According to the World Health Organisation, half of the European population will be infected with the Omicron variant in the next few weeks. In the face of the rapid spread of the pandemic, the World Bank has lowered its global growth forecast for 2022 from 4.3% to 4.1%. Subsequently, the Managing Director of the International Monetary Fund (IMF) said that the world would face more uncertainty this year in light of the slowing recovery, inflation, and supply chain issues. Next week, all eyes will be on the Federal Reserve's interest rate meeting on 26 January and the latest developments of the global pandemic.

Europe

European equities had a mixed week, with the UK FTSE 100 index gaining 1.52% over the past five days ending Thursday, while Germany's DAX and France's CAC fell by 0.13% and 0.67% respectively. The Eurozone CPI rose 5% YoY in December last year, a record high since 1991. The market is concerned about inflation in the region, with Bundesbank President Joachim Nagel saying that the current inflation outlook is still highly uncertain, and that the central bank may need to adjust the monetary policy if inflation exceeds expectations. As for the policy rates, the ECB's chief economist said it was very unlikely that the bank would raise interest rates in 2022. Next week, the Eurozone will release its ZEW survey expectations for January, while the UK will release its CPI for December.

China

The A-share and Hong Kong stock markets moved in opposite directions this week, with the CSI 300 Index fell 1.98% over the week, while the Hang Seng Index rose 3.79%. Inflation data in China eased, with the PPI and CPI up by 10.3% and 1.5% YoY in December, down from 12.9% and 2.3% respectively. As for aggregate financing and new RMB loans in December, both recorded declines from the previous values to RMB2.37 trillion and RMB1.13 trillion respectively. RMB-denominated exports improved, the December figure rose 17.3% YoY, up from last month’s 16.6%. Next week, China will release GDP figures for both 2021 Q4 and the full year, as well as fixed investment, industrial production, and retail sales data.

  US

Global equities got off to a poor start in the New Year, the US market fell in line, the S&P 500 was down 1.47% over the 5 days ending Thursday, the Dow shed 0.44%, and the technology-heavy NASDAQ lost 4.2%. The decline in the US market was attributed to signals from the US Federal Reserve to speed up the “tapering" process. The released Fed December minutes indicated that interest rates may be raised earlier than expected, and subsequent tapering of the balance sheet is considered. Later, St. Louis Fed President Bullard said the Fed could start raising interest rates as early as March, and then it could start trimming its balance sheet. According to Bloomberg interest rate futures data, the probability of a rate hike in March rose to nearly 80%, and the market is worried that the accelerated pace of rate hikes may put pressure on the economy. The VIX index, a reflection of market fears, rose to 21.06.

On the economic front, the number of initial jobless claims rose in the US, but was still close to a record low; while the number of US ADP jobs added in December was the highest in seven months. Nonetheless, the ISM Manufacturing and Services indices were 58.7 and 62.0 respectively in December, both lower than the previous reading and missed market expectations, reflecting weakening economic activity. Next week, Hearings on the re-election of US Federal Reserve Chairman Jerome Powell are scheduled for 11 January, while hearings on the nomination of Lael Brainard as Vice Chairman will also be held on 13 January. In addition, the US will release CPI, retail sales, University of Michigan market sentiment data, and the Fed will publish the latest Beige book.

Europe

European equities had a better run than the US, with the FTSE 100 up 0.89%, Germany's DAX up 1.05%, and France's CAC up 1.35% in the first four days of 2022. European benchmark gas prices for next month's deliveries rose by 20% at one point due to a reduction in gas deliveries from a key Russian pipeline through Ukraine. In addition to gas prices, markets were also concerned about inflation in Europe, with Germany reporting a 5.3% YoY figure for December CPI, higher than both market expectations and the previous reading. ECB Governing Council member Martins Kazaks said the bank would take action if the inflation outlook worsened. Another member of the Governing Council, Francois Villeroy de Galhau, expects inflation in the Eurozone to be nearing its peak. Next week, the Eurozone unemployment rate and the Sentix investor confidence index will be released.

China

Hong Kong and Mainland equity markets diverged heading into 2022, with the CSI 300 Index falling in recent days, 2.39% lower over the week, whereas the HSI rebounded on Friday, reversing its weekly weakness and rising 0.33% over the week. On the data front, the Caixin China Manufacturing and Services PMIs for December were 50.9 and 53.1 respectively, both improving over the November figures. Premier Li Keqiang called for greater tax and fee cuts, as well as special support for the service sector and other areas severely hit by the epidemic, to ensure steady economic growth in the first quarter. China will release CPI and PPI figures for December.

The latest inflation data in both the US and Europe remained far above the long term target, supply chain disruptions could be here to stay for an extended period. Henceforth, driving the need for global central bank action, further tightening is expected. At the time of writing, interest rate futures showed that markets are now pricing in 2-3 rate hikes for the Fed in 2022, other central banks apart from the ECB and the BoJ are also expected to walk on the same path, so as to stem the rapidly surging inflation.
This makes for a difficult case for investing in fixed income. With future rate hikes expected, the current downside risk in form of interest rate risk increases. If one does need to invest in the fixed income market, we continue to hold our ‘high yield over investment grade’ view, but investors would need to pay attention to 2 things. Duration should be minimised, so as to reduce interest rate risk. Equally important is the credit quality, as tighter liquidity conditions, dialled down fiscal stimuli, and a slowing economy all pose as a risk to weaker companies.