Credit Market Daily #21

22-Sep-2022

Good Morning!

Two down and One to go. We have the Bank of England today at 12.00.

The Fed’s 75bp rate rise was as expected, the rates outlook however was more hawkish than anticipated and points to higher rates for longer into 2023.

What really struck me was the price action during the Fed’s presser.

It continues to speak of a low conviction equity market that has yet to fully accept the regime change. The Fed did what was expected – and yet the S&P manages to swing -1.7%, +1.96% and -2.6% into the close.

The Fed (and all central banks) are weaning the markets off liquidity, whether the “Fed Put” is truly dead remains to be seen but certainly will not be tested any time soon.

Rates will be higher for longer, credit spreads wider and equities lower over the medium term.

With the Fed out of the way I suspect we go back to the cycle of watching economic data points for signs of inflation being slain and unemployment rising, building the next set of expectations for the next central bank meeting.

In the meantime, at a fundamental level, credit metrics will likely soften.

S&P 500 Intraday chart – Down, Up, Down
S&P 500 Intraday chart, 21-Sep-22

Credit

High Yield

An interesting day in European High Yield.

At the index level performance was relatively flat with European high yield returning -29bps on the day, the index credit spread some 6bps wider on the day with High Yield underperforming equities in Europe.

Stirling and Dollar High Yield returned up +25bps and +7bps on the day, and the Itraxx Crossover widened +5 bp to c.601bps.

The interesting part was in single names.

WFS € 6.375% 27 bonds jumped 10 points on headlines that Singapore’s SATS (another gateway services provider) said it was looking at funding options for the acquisition of WFS and was in talks with WFS’ PE backer Cerberus. (Not all assets are overpriced?)

European Retailer Ceconomy’s bonds fell 6 points post a 2 Notch downgrade from Moodys from Ba1 to Ba3 with a review for further downgrade. That is effectively going from near investment grade to “proper” high yield with a Single B rating on the horizon.

“The downgrade was driven by the increasingly challenging economic environment, with already strong evidence of high inflation affecting consumer spending, as well as rising operational costs, which will further pressure Ceconomy’s weak margins. This will lead to material negative free cash flow generation in 2022, which will in turn weaken the company’s liquidity”

Moody’s Investor Service

In GBP High Yield Consumer-facing companies continued their move lower after last week’s rally. There is upside risk in tomorrow’s mini-budget so we may see some recovery but overall higher interest rates will weigh on the consumer.

Finally on the new issue front – Citrix launched with Eliott Investment Management buying $1bn of their own deal in order to support the transaction in signs that the high yield bond market is open but investors are being very selective.

At the time of writing, Xover is opening 10bps wider at 611.

Leaders and Laggers

Investment Grade

European Investment grade also had a relatively flat day. The New issue market was open but limited to government-linked agencies or supranational issuers with no corporate issuance and a focus on high quality.

Given the focus on the Fed and also the rhetoric on Russia risk appetite was light. I would imagine this changes today now the FED is out of the way.

In terms of spread performance, the European Corporate Agg was 2bps wider on the day with a total return of +2bps on the day. Long duration, highly rated issues outperformed as there was some giveback in long end rates from the prior day.

Overall European IG looks to have underperformed European equities yesterday.

In CDS the newly rolled main index underperformed Xover +2bps wider on the day

Rates

10-year Treasury, Gilts and Bunds Yield 354bps, 331bps and 189bps respectively.

The 2 Year UST breached a 4% yield yesterday as we headed into the FED meeting, spiking 10 basis points on the initial announcement to 4.11% before ending the day at 3.96%

The bear flattening of the UST curve continues to point to recessionary pressures – which the Fed were keen to warn of (see below).

2yr UST Rates approaching levels not seen since ’07

Rates are opening tighter across the board this morning.

In the UK the long end is performing, -6bps tighter, whilst the move in the front end is less -1 to -1.5bps.

Equities

Equities are opening flat to small-down in Europe having outperformed the US which sold off post the FED meeting.

The Bank of England will likely set the direction and tone today in the UK and futures currently suggest.

Today’s Events

Bank of England at 12.00 and Continuing Claims and Leading Index.

What Has Caught Our Eye

Fed – Summary

Powell purposefully kept his speech and Q&A short – he really wanted to reiterate the hawkish message of Jackson Hole and show that the FED was behind the 8-ball in terms of its focus on getting inflation down.

What the dot plot and statement pointed to were higher rates for longer – the market was caught off guard by the expectation that rates would remain high throughout 2023.

Check out the cool animation from the FT (right-hand tweet below). It shows you how the dot plot has changed over time.

By keeping the presser short I think Powell was limiting the chances that his words could be taken positively by a market sifting for signs of a pivot.

Also worth noting is that the FED reduced its GDP growth outlook and its expectation for unemployment – the quote below is pretty clear in terms of the cost of getting inflation under control.

There is no easy path forward, but it is one the Fed duty bound to take.

Any signs that the FED is over-tightening will likely be taken very badly by the market, but are for the future.

Having been behind the curve as inflation rose it is hard to think they will want to take their foot off the gas at the first signs their policies are taking effect.

 “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

J Powell 21-Sep-22

Earnings Estimates Turning Lower

These charts from Jurien Timmer director of Global Macro at Fidelity show that US earnings expectations and estimates are beginning to turn down in Q4 ’22 and for 2023.

For Q3 ’22 earnings estimates look to be holding up with +4% growth expected.

We would expect European corporates to fair worse than their US counterparts and we think it very important to keep an eye out for headlines and data points that point to softer earnings and earnings misses

Q3 ’22 US Expected Earnings growth positive at +4%
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US Earnings Estimates for End 22 and for 2023 are turning lower
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Earnings growth Momentum slowing – 2022 Ex Energy is + 3%
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Performance

High Yield

Investment Grade

Rates

Equities

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