Credit Market Daily #20

21-Sep-22

Good Morning!

We are back after a Bank Holiday Hiatus.

This week is all about the size, pace and indication of the duration of rate hikes. Today we have the FED and tomorrow BOE with expectations of 75bp and 50bp rises respectively.

The BOE is expected to more than double rates between now and the end of March ’23 to around 4.5%. (UK rates took a bath yesterday, see below)

Government support will complicate matters for the BOE in the UK and we have “Fiscal Friday” this week when the new Chancellor will announce his mini budget for the UK.

This leaves some room for an upside surprise to the markets at the end of the week in the UK at least.

For the Central Bank pressers, I suspect for today the best markets can hope for is pragmatism from the FED in terms of the pace of hikes and data dependency.

Coming back to such a big “Macro” week it is good to see that there is still a lot happening in “Micro”.

Friday saw FedEx steal the headlines with its CEO commenting that he expects the global economy to enter a recession with package deliveries down and warning that Q3 profit would be about half that of analyst expectations.

Monday evening saw another bellwether – Ford also came out with a profit warning, although full-year earnings guidance was reiterated.

Ford spoke to an additional $1bn in inflationary costs as well as supply chain issues negatively impacting its profits.

Finally, clothing retailer GAP is cutting c.5% of its corporate staff in order to curb costs.

So – there are signs of slowing at the corporate level and earnings are likely to come under pressure and this should also start filtering through to credit spreads and yields.

Back to Macro – Putin is upping the stakes in the Ukraine war mobilising reservists and and threatening the use of nuclear weapons -this too will weigh on sentiment.

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Credit

High Yield

High Yield has continued to be relatively soft in the last 2 days but continues to outperform broad equities, month to date.

The primary market is open – with the Citrix benchmark deal in the US – it looks to be getting done – but only just with the high yield bonds coming with a 10% + yield and issue price of c.83.5 compared to the normal 100.

In Europe last week’s issue by Lottomatica – a 9.75% Secured 5 Year -Non Call 2 is trading above par at around 101.

For context, its existing fixed rate bonds priced in ’20 and ’21 have coupons of 6.25% and 5.125% respectively. That is a 25% increase in its cost of debt vs. the 6.25% bonds.

Luckily the number of issuers who have to refinance is relatively limited, as most issuers termed out their debt structures in ’20 and ’21.

One interesting issuer is IT services provider Inetum which has announced a €300-400 bond deal. Bloomberg reports that the company was originally looking to raise c.€1bn in the loan market.

The company is having to come to the high-yield bond market as the loan market’s liquidity is poor with loan market participants not having a lot of cash to spend as issuers have reduced pre-payments and redemptions. High Yield investors – as per our Q3 survey with Bloomberg Intelligence – had around 7% cash – the highest since we started the survey in ’20.

Finally – we had the Xover CDS index roll. The new series was around 46bps wider than the old. The old series ended the day 10 basis points wider on the day.

Leaders and Laggers

Investment Grade

Investment grade continued to underperform High Yield as rates on both sides of the Atlantic rose.

The chart below shows the difference between the Pan European Corporate Aggregate Index’s Yield (light blue) and its Spread (light green). The difference is shown in the second panel (red line).

As you can see – the index spread- credit risk – has increased over the year but is dwarfed by the normalisation of rates.

Central banks will be glad to be out of the negative yield environment of 2019 to early ’22.

The average difference of Yield – Spread since 2000 was 198 basis points, so at 203 we are just above the average.

Credit spreads will likely widen as the economic cycle slows and earnings start to decline.

Pan Euro Corporate Aggregate – Yield Decomposition

In terms of performance, the European Investment Grade Index lost -71bps on the day. Longer Maturity underperformed with the 10-year + bucket losing -152bps on the day.

GBP investment grade lost c.-91bps on the day while US IG lost -48bps.

New issuance in European IG was quieter with 4 corporates and around 8 Financials in the market.

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Rates

Rates was a bit of a blood bath in the UK with Gilts 19bps wider in the front end and 15bps in the long end continuing the bear flattening with expectations of frontloading of rates in the UK.

The Gilt curve will be interesting to watch into the BOE and then into “Fiscal Friday”

10yr treasuries, gilts and bunds yield 356bps, 329bps and 192bps respectively.

Interestingly I am seeing an increasing number of press reports that “TINA” or “There is No Alternative” to equities is well and truly dead and buried with government bond yields reaching new recent highs.

Dare I say it – bonds are cool again!

Rates look to be tighter this morning with Putin’s call for partial mobilisation in its war with Ukraine.

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Equities

Equities were lower across the board yesterday and are opening flat with futures pointing to a slightly positive open in the US.

Given the FED meeting where we are by the end of the day will be anyone’s guess.

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Today’s Events

Eco Data

The FED. That’s it.

Reporting

Maxeda

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What Has Caught Our Eye

Investment Grade – BBBs grow

The always worth a read BIS quarterly review flagged the increase in risk within IG benchmarks as credit quality has migrated lower with an ever increasing volume of BBB rated debt.

Whilst we can’t argue with the increase in lower rated debt in the indices, the credit risk compared to high yield is considerably lower.

Indeed, we read an article just yesterday on Bloomberg where a portfolio manager described the rating bucket as the “sweet spot” in IG in a risk/ return context.

“The steady decline in the credit quality of IG indices reflects two broad trends in corporate markets. The first is search for yield in an environment of persistently low interest rates. Bonds rated BBB are particularly attractive to IG-focused investors that seek to earn higher yields, including many mutual funds.  

The second broad trend is the general increase in issuance by BBB-rated firms, which accelerated with the launch of several central bank asset purchase programmes that further reduced these companies’ cost of funding.”

BIS Quarterly Review, September ’22

So bad that it is good?

A couple of tweets showing equity sentiment is so low that it should/ could provide a bounce in terms – every cloud has a silver lining?

A Couple of Podcasts – Central Bank Credibility, Hiking Till it Breaks

These podcasts both touch on USD strength and what that means for the world as well as the importance of central bank credibility and why, being behind the curve, central banks are likely to over tighten before any “pivot” comes to the markets rescue.

Performance

High Yield

Investment Grade

Rates

Equities