Earnings season – the end of the corporate party? NGEU implementation, latest from Sweden’s Rijksbank & Sino-US relations; And the implications of QT

There are usually three ingredients in a good life: learning, earning(s) & yearning. While corporate earnings flourished in 2022, the performance in set to reverse in 2023 and protecting margins will be among the top priorities. Central banks (learnings): The gradual reduction of asset holding under the ECB’s quantitative tightening (QT) strategy will shift the focus to unwinding TLTROs (targeted longer-term refinancing operations) funding, significantly impacting both bank lending and capital markets. And in Sweden, the Rijksbank struggles to control supply-side-driven inflation, with tighter financing conditions creating havoc in the housing market. Moreover, the latest prudent economic targets by the Chinese National People’s Congress, and a closer look at why an effective implementation of Europe’s Next Generation EU (NGEU) is quintessential for the Green Deal Industrial Plan to succeed. Plus a recent CNBC interview with me commenting on the “recession-avoided syndrome”?of markets.

In focus – Earnings season: The end of the corporate party?

You’ll find the complete ‘hot’ topic report including the feature story here.

Despite a general business deterioration in Q4, 2022 was a strong year overall for corporate earnings. Global revenues jumped by +11.7% y/y and earnings per share (EPS) by +4.3% y/y. 15 out of 23 sectors reported growth for both revenues and EPS, with oil & gas, transportation and hospitality being the biggest winners of the year.

However, the excellent performance is set to reverse in 2023, notably for shipping and retail. The build-up of oversupply, capped pricing power, still-high input prices and waning demand will squeeze margins in some sectors. Conversely, consumer services (hotels & restaurants) and airlines should continue enjoying high booking rates as rising prices do not appear to be a deal-breaker for traveling.

With no major revenue growth likely in the first half of 2023, protecting margins will be the top priority. Cost-cutting strategies such as restructuring and personnel rightsizing should continue in the near term, notably in the US, where profitability is declining more rapidly. However, we still expect further capital expenditures in 2023, mostly in sectors where a switch towards sustainable projects is needed the most (automotive, energy and utilities).

What topics to watch

Europe’s Next Generation EU (NGEU) – Forget me not! Europe’s Green Deal Industrial Plan will not work without an effective NGEU implementation.

Varning Sverige! Are we reaching the end of the hiking cycle? As the Riksbank struggles to control supply-side-driven inflation, tighter financing conditions are already creating havoc in the housing market. The monetary policy trade-off is becoming increasingly costly. Is Sweden a bellwether for the Eurozone?

China – National People’s Congress: prudent economic target and harsher rhetoric on geopolitics. Chinese authorities have confirmed a higher GDP growth target of +5% for 2023 aimed at striking the right balance between policy support and structural reforms. However, a harsher rhetoric means no relief in sight for tense Sino-US relations.?

You’ll find the complete ‘hot’ topic report including the feature story here.

Easy come, easy go: The impact of quantitative tightening on money, credit and market plumbing in the Eurozone

The comprehensive analysis for you here.

The ECB is likely to remain hawkish as inflationary pressures abate only slowly. Against the background of tightening financial conditions and excess liquidity absorption, we have explored the expected impact of the ECB’s quantitative tightening (especially due to TLTRO unwinding) on credit growth, corporate credit risk and market liquidity:

Since 2014, asset purchases and targeted longer-term refinancing operations (TLTROs) have been the two main planks of quantitative easing (QE) in the Eurozone. The ECB’s asset purchases led to a significant compression of term spreads, easing financing conditions in the effort to lift inflation to the price stability target. TLTROs complemented asset purchases by providing cheap liquidity to the banking sector, and, thus, strengthening the lending channel of monetary policy, especially during the Covid-19 crisis. But TLTROs have taken a secondary role behind the market-moving asset purchase programmes (APP and PEPP).

Now, the gradual reduction of asset holding under the ECB’s quantitative tightening (QT) strategy will shift the focus to unwinding TLTRO funding, which will remove most of the system-wide excess liquidity. We expect that the repayment and redemptions of TLTROs will contribute about three-quarters of the ECB’s balance sheet reduction until mid-2024 amid a relatively slow runoff of asset purchases.

The unwinding of TLTRO funding will significantly impact both bank lending and capital markets. On one hand, the drawdown of excess liquidity will boost market liquidity through the release of collateral; this will help tighten asset swap spreads, a measure of collateral scarcity, which facilitates market-making in quote-driven markets, such as government and corporate bonds. On the other hand, we estimate that removing TLTRO as a cheap funding source for banks will amplify the current decline of credit growth (y/y) by about 1.4pp each month on average. For capital markets we expect a non-negligible impact on corporate credit-risk pricing, with both investment grade and high yield segments widening by +10-15bps and +40-50bps, respectively.

If inflation remains higher for longer, the ECB could be forced to tighten monetary policy further, including by reducing its asset holdings above the amortization rate; this could intensify the effects. However, while the ECB is expected to increase the rate of passive asset run-off, a proactive balance sheet reduction seems unlikely due to its significantly disruptive effect on market dynamics; for instance, the release of collateral by more vulnerable Eurozone governments and corporates could spur spread widening, and raise the risk of fragmentation during a time of further monetary tightening.

The comprehensive analysis for you here.