Bottom-line: Q1 is still all about central banks, with recent hikes and hawkish commentary pushing Fed funds futures to a peak of 5.19%; nearly a full hike higher than at end-Jan. But the US GDP forecast for 2023 has also inched higher from 0.5% to 0.6%, with more room to go (unemployment at 3.5% implies US real GDP growth at 1.5-2.0%). Inflation is coming off although still high given the tight labour market – could be offset by tech layoffs & lower personal savings rates. A soft landing / recession fears being pushed out, coupled with still low equity positioning, means the pain trade is higher equity markets. Inflation at 2-5% suggests an S&P500 return of 12.6% (table below) – one way of reading this is that we’ve had an ~8% rally YTD and could rally another ~4.5%; or just that 2-5% inflation is a sweet spot for equity returns until / unless Fed hikes cause a recession. Rising real rates and deeply inverted yield curves curb our enthusiasm. Trades: bear fences on the Top40 and S&P500 with strikes at 90 / 100 / 104-5 out to Jun’23 (indicatively priced at zero-cost). Watch: US CPI later today – consensus 6.2%; majority 6.1-6.4%; previous 6.5%
Updating our equity index derivatives – rolling over the bullish trades we published in October into more cautious ones until Jun’23
- Top40 … sell 90% put, buy 100% put, sell 104.5% call; zero-cost out to Jun’23
- S&P500 … sell 90% put, buy 100% put, sell 104.1% call; zero-cost out to Jun’23
* indicative pricing only (edpricing@investec.co.za for updated pricing / other strike iterations)
Central bank round-up
- Fed … 25bp hike (vs. 50bp in Dec, 75bp hikes through 2022); QT pace maintained. Disinflationary process in goods underway but core services PCE ex-housing has shown little improvement. Dot plot shows a terminal rate range of 5.00-5.25%; i.e. 2 more hikes of 25bp each. Implied peak rate from Fed funds futures has since moved higher to 5.16%. Investec forecasts one more hike of 25bp in March, with CPI inflation at 3.9% by May and on its way to the 2% target allowing for the Fed to pause
- ECB … 50bp hike; QT pace maintained. The ECB guided for another 50bp hike in March, whereafter the monetary policy path would be reevaluated (25bp vs 50bp hikes, ‘more ground to cover’). Investec forecasts a final 25bp hike in May, after the 50bp March hike
- BoE … 50bp hike. “Inflation risks are more skewed to the upside than any time in the MPC’s history” (labour & energy markets). If rate peak at 4.5% (vs. 4.0% now), the BoE sees a five-quarter recession, starting in the current quarter. Investec forecasts one more 25bp hike in March
Best,
Nadeem