Credit Market Daily #17 %author %

14-Sep-2022

Good Morning!

Expectations met reality yesterday as US CPI came in stronger MoM than the market was expecting.

The result – was the largest sell-off in stocks since June 2020. Credit, Equity and Rates all sold off.

Nowhere to hide.

On Monday we asked the question – “What has changed?” Fundamentally we had the UK fiscal support and the Ukraine counter-offensive. Outside of that the fundamentals remain the same – slowing growth, tightening central banks, tight labour markets and lower earnings.

We have seen with the NFP number and now with CPI that when expectations fall short or challenge a narrative – in this case “the Fed will Pivot” then risk assets take will take a hit.

The way I think about markets is as if I am sailing on the Ocean. The tides and winds determine how easy it is to reach your destination – these are the long-term fundamentals.

Known knowns and known unknowns that can be planned for. Rising rates, lower earnings, higher default risk.

Then you have the weather – generally shorter term in nature but it can have a high impact on your journey. These include your known unknowns and unknown unknowns – that can only be prepared for e.g – ensuring you have life jackets or a sturdy lifeboat (Cash).

Fundamentally – for some time – the tide and winds have been against us. The turning of the tide will take time.

Central banks will likely want to see several consecutive months of slowing inflation or softening employment before any “pivot” to providing liquidity.

Fiscal stimulus is coming and has the potential to cap inflation and stave off recessions – again this takes time. Which some businesses may not have – the FT reports – the UK’s rescue package may not be available for businesses until November.

A week ago I said I thought we could see capitulation in the markets and then we rallied. I still think the tides and the winds point to tougher economic times before things get better. (point in case – German consumer confidence yesterday plumbed new all-time lows).

In writing a daily newsletter the focus is often on the day’s expected weather and looking for signs that the tides and winds are changing.

Given the sell-off, it seems a good juncture to reiterate what I see as the direction of travel.

Fiscal support and what is hopefully the Start of the End of the war in Ukraine have the power to turn fundamentals and are long-term catalysts.

The undercurrent from central banks will take longer – 2 to 3 months before we can point a change.

In the meantime, we will have peaks and troughs but the current destination over the next 3 months or so remains lower prices and wider credit spreads.

Yesterday’s squall in markets came about because markets were again focussing on one data point and expecting it to be supportive of a narrative that must, I think, be dependent on multiple data points and a general change in the tides and winds.

Credit

High Yield

High Yield held up relatively well looking at the Bloomberg Indices. There tends to be a lag when you have large moves so yesterday’s relative outperformance relative to the large moves in equity is likely to play catch up.

European High Yield returned -21bps on the day, with the index spread actually flat on the day at around 534. Looking at cash prices on Bloomberg this morning we look to be 0.25-0.625 points lower.

Of interest is going to be whether the high inflation print has effectively shut the door on any primary issuance which was tentatively gathering momentum yesterday.

The USD index was down 1% on the day in terms of performance – with all rating buckets returning a similar amount.

One thing to note that comes up when we discuss USD HY in our quarterly webinar is the importance oil has in the index in terms of industry weight – yesterday WTI continued its leg down and a drop below $75 increases the risk of the index as oil producers become less profitable.

GBP HY was down 41bps on the day again its credit spread was relatively flat on the day a 619bps.

Xover widened some 22bps to end the day at 530 and is opening at 538 this morning which seems relatively orderly given the rout in US equities yesterday.

In terms of single names – Monti de Paschi’s junior debt rallied some 3 points in the Markit Iboxx High Yield Index – this was on the back of headlines that the state-owned bank’s commercial partner was willing to play a role in shoring up the bank’s capital.

In the GBP Markit Iboxx Index Ocado was the loser on the day down 1.7points on the back of a soft trading update with revenues missing market consensus.

We wait to see how the primary market develops this morning.

Leaders and Laggers

Investment Grade

Having outperformed high yield the last couple of days European Investment grade underperformed as rates went higher on the back of yesterday’s CPI print.

The Bloomberg Pan European Corporate Agg returned -51bps on the day – like High yield the index spread was flattish , +2 bps on the day at 196bps.

We would expect credit spreads to play catch up today.

The Itraxx Main was 2bps wider on the day at c110 bps continuing to outperform Xover.

The GBP and USD indices returned -73bps and -47bps on the day, again credit spreads were flat with the decline in value coming from the increase in yields.

Rates

Rates were wider across the complex yesterday with the belly widening most in Europe and UK. In the US it was the 2-year treasury that took the brunt of the high CPI print reaching highs not seen since Nov’07.

The 2s10s spread became more negative touching -33bps as the UST curve flattened further.

Bloomberg also reports that the rates markets are pricing at 32% probability of a 100bp rise by the FED next week, with a 68% probability of 75bps.

The Fed Pivot narrative has been put to bed for the next week at least. The Fed meeting will be scrutinised for any dovish signs, however unlikely.

This morning rates appear to be opening tighter across the board.

The 10yr Treasury, Gilt and Bund yield 341bps, 317bps and 170bps respectively.

Equities

This Gif captures the lack of conviction in “pushme-pullyu” equities:

This Screen shot captures the reality of yesterday’s moves:

Futures look to be small up in the US and down -50 to -70bps in the UK and Europe.

Today’s Events

UK CPi has come in slightly better than expected, we have UK house prices US PPI and mortgages applications:

Reporting

Akropolis

Bombardier

Ideal Standard

NovaFives

Olympic Entertainment

Tullow

What Has Caught Our Eye

Move vs. Vix

Yesterday the Vix – equity volatility index – spiked to 27 up 14% on the day. Whilst the US fixed income volatility index increased 5%.

Returning to the analogy of sailing, the Move index has been pointing to headwinds and cross-currents for some time whilst equity volatility has yet to really wake up, although it has been trending higher since October.

CPI – Aye, Aye, Aye

The image below is from the WSJ “U.S. Inflation Remained High in August” – essentially the MoM Core figure shows signs of sticky inflation which will keep the FED hawkish.

Note Housing represents roughly 1/3 of core CPI and is somewhat lagging and there are signs of the housing market cooling in the US.

“These data are hot and are a reflection of feed-through of higher energy prices from earlier this year. Inflation is a stubborn thing,” said Jamie Cox, managing partner for Harris Financial Group, in a statement.
WSJ

This image

Aldi Becomes UK’s fourth Largest Grocer

Bloomberg reported that Aldi has overtaken Morrison’s as the UK’s 4th largest retailer according to Kantar.

This clearly points to consumers looking to save on their grocery bills as the cost of living bites.

The big three Tescos, J Sainsburys and Asda all lost market share down -50bps, -40bps and -30bps YoY respectively. Lidl’s market share is up 100bps over the same period.

As mentioned above Ocado’s Q3 sales disappointed as “Consumers are shopping smaller baskets and seeking value-for-money items as they respond to inflationary pressures” the company commented.

High Yield Issuer Iceland’s market share has remained steady.

Credit Market Daily #17