With lingering concerns about a hard landing in the US and a broader global growth slowdown, we continue to prefer high grade issuers of select industries that we think will remain resilient against the backdrop of possible volatility in 2023 and that will benefit from China’s reopening. As for duration, we reiterate our preference for 5- to 10-year high-quality credits.
Here are the sectors you may consider:
Power sector: As a non-cyclical industry, we see value in the power sector amid the risk of a global growth slowdown. This will also be supported by China’s energy transition (e.g., solar projects, energy storage, electric vehicles).
Oil Sector: Despite potential recession risks, oil producers will benefit from China’s reopening and the willingness of the members of the Organization of the Petroleum Exporting Countries and other countries that export crude oil (OPEC+) to further cut supply to support oil prices. Additionally, the US has followed through on plans to begin re-filling their petroleum reserves on dips in crude prices, which will help keep prices down.
Transport sector: Revenge travel may intensify in 2023, especially with the return of Chinese tourists. Moreover, hybrid work arrangements will continue to boost traffic and encourage people traveling for work to extend their trips for leisure.
Technology sector: Investment-grade (IG) tech is generally a defensive sector. It outperformed the IG index given the risk-off environment in 2022. We prefer higher-quality and less cyclical tech names with A and BBB ratings.
We also favor adding exposure to China credits as the country’s earlier-than-expected reopening and the government’s focus on economic growth, away from draconian COVID curbs, continue to boost risk sentiment for the region.
As for clients mostly looking for interest accrual, we recommend locking in yields for as long as possible while yields are near recent highs. Take advantage of US dollar investment grade credits with yields of at least 5%, which, we believe, is decent already for the next five to 10 years.
The US Federal Reserve raised interest rates by 25 basis points (bps) to a range of 5% to 5.25% and hinted that a pause in June is on the table. The Fed notably changed its language, no longer saying that it “anticipates” further rate hikes, only that it will monitor incoming data to determine if more hikes “may be appropriate”.
Another sell-off in shares of US regional banks continued to weigh on US equities as the recent failure of First Republic Bank triggered more concerns about the financial health of other mid-sized lenders. Mixed US economic data, however, kept benchmark rates and credit spreads mixed, and only little changed after a week of market volatility.
For the week ahead, eyes and ears will be on the Fed and European Central Bank (ECB) meetings. Given the persistently high inflation in the US and Europe, the market expects both central banks to hike their respective policy rates by 25 bps. Investors will be more interested in their forward guidance as the market is pricing this as the last hike of the Fed, and, for the ECB, just 50 bps more hikes after May.
Although there is still room for rates to inch up further, the peak in benchmark rates is near. The next big move would therefore be for lower rates. Growth concerns, on the other hand, will pressure spreads wider. Given this, we prefer to buy stable credits on any sell-offs (see latest strategy update) and continue to look for primary issuances to benefit from wider issuance premiums.
Inflation in the US appears to have peaked, but it is still well above the US Federal Reserve’s 2% target. Tight labor market conditions (i.e., more demand for labor than supply of job seekers) continue to keep wages high, which, in turn, allow consumers to keep spending despite soaring prices and elevated borrowing costs. For as long as wage growth points to persistently high inflation, the US Fed will continue tightening monetary policy to curtail demand and achieve its inflation target. Elsewhere, central banks in Europe have also maintained their hawkish stance, with inflation readings in the UK and in the Eurozone still above 10%.
The US Fed has acknowledged the delayed impact of a tighter monetary policy, which means that the resulting contraction in economic growth due to last year’s rate hikes may come later. Because of this, the Fed has slowed the pace of hikes, raising key rates by 50 basis points (bps) in December 2022, after three consecutive 75-bp rate hikes until November. The easing pace of Fed rate hikes, moderating US inflation, and unemployment numbers at historically low levels have revived the case for a “soft landing”, i.e., no US recession. However, the risk of a “hard landing”, or the US economy going into recession, remains elevated as the Fed continues to raise rates in a slowing economy, especially as the cumulative effects of past policy actions have yet to be fully felt.
China has shifted its policy stance towards boosting economic growth and maintaining a “proactive fiscal policy”. As the world’s second-largest economy, it has begun to implement support measures for its troubled property sector and initiated its exit strategy from its zero-COVID policy. Military-related tensions between the US and China have also eased following Joe Biden and Xi Jinping’s in-person discussion, boosting market confidence in the region. Nonetheless, the path towards reopening and the stability of the current geopolitical landscape hang in the balance.
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