Credit Market Daily #29 %author %

04-October-2022

Good Morning!

Yesterday the relief rally we were looking for on Friday happened with Rates, stocks, credit and oil ending the day with positive returns.

The Conservative conference seems to be having a positive influence on the Chancellor and PM; with the latter stating that he will produce his plans on funding the Energy package and mini-budget this month.

The Chancellor originally stated he would give details of how the mini budget is being funded at the end of November which would have been post the BoE meet.

This would have complicated things as the Bank would not have had all the facts in its possesion at what will likely be a key rate hike.

The announced change has to be taken positively.

That said the UK has some way to go to repair its standing with markets.

Black Rock’s chief investment strategist was on Bloomberg TV yesterday saying they were underweight UK gilts (long the short end) and equities on the back of their view on UK’s weakened fiscal credibility as well as concerns around recession risks not being priced into developed market earnings expectations.

As to the rally itself – “peak rates” is being heralded as the reason for the positive price action across the globe – again if we ask ourselves what has changed it is hard to argue that this is the case.

As we have flagged before sentiment and positioning had been extremely bearish so the technical support for a rally in risk assets is definitely there.

Credit

High Yield

Xover outperformed cash 16bps tighter on the day or +58bps in price terms.

Interestingly the Xover: Main ratio has headed lower over the last 10 days and is currently 4.72x down from c.4.93x on the 22-Sep.

The long-term average is 4.6x and Main’s relative underperformance likely reflects Xover’s being used as a hedge and greater short positioning in the latter.

I had wondered if CS ‘ Senior CDs widening had some impact on Main – but the +114 bp move since 22-Sep when weighted accounts for only 0.8bps widening in Main and the Senior Financial CDS Index has been outperforming Main for some time now (See below)

The European, Sterling, and Dollar High Yield Indices returned +6bps, +15bps and +54bps on the day respectively.

US High Yield reversed the previous day’s losses and played catch-up in line with equities.

Spread performance in European, Sterling, and Dollar High Yield Indices was +20bps, +28bps and +3bps, representing an increase in credit risk.

Indeed – looking specifically at European High Yield BB’s outperformed returning +22bps on the day, whilst Single Bs and CCCs actually had a negative return on the day both returning c.-26bps on the day.

European High Yield did not get the memo about the Rally being broad-based, as was the case in the US with all rating buckets performing positively.

Leaders and Laggers

In single names, Metal Corp Group’s bonds fell c.6pts on headlines that it was seeking a 1-year extension on €70mm of debt that was due. The company had been looking to refinance the loan with a mix of cash, commodity financing and a new loan but market conditions were too poor for them to do so.

Refi risk has been on the whole pushed out by most issuers, but remains a risk for some, especially the weaker rated names.

The Charts below show which companies have debt coming due in the European and GBP high yield markets in the next 12 months.

CCC/ B- index-rated names are highlighted in Red. Important to note that Matalan is currently restructuring its 2023 maturity to a 2027 maturity.

Total Debt Due for GBP is c. £2.3bn of which Matalan is £350m. Total debt due in Euro HY 12 months is c.€26bn of which €2.7bn is rated B-/CCC -.

Investment Grade

European Investment Grade outperformed High Yield and most European equities yesterday returning +92bps. Low coupon, highly rated and long duration names leading.

Sterling and Dollar Investmentgrade returned +55bps and +119bps respectively given the rally in rates.

In spread terms, performance was similar to that in High Yield with European spreads 4bps wider on the day, GBP +4bps wider and US Investment Grade flat.

In CDS Main, like Xover outperformed cash with spreads tightening by -2bps to 132 and is opening 5 tighter at 127.

Looking at the ratio of Senior Financial CDs to Main there has been a steady outperfromance of financial CDS, despite the moves in Credit Suisse since the beginning of the year.

This article from the FT on the weekend “UK banks set for bumper profits despite mortgage market freeze” speaks to the likely bumper profit that banks will enjoy given the rise in rates. Impairments are likely to increase over time but it looks like banks will have ther moment in the sun.

“There’ll be an embarrassment of riches — bank margins will look very wide in the third quarter,” said one senior banker, describing it as “a cha-ching moment”.
FT, UK banks set for bumper profits despite mortgage market freeze, Oct-1

The new issue market was agin closed to corporate but should – given the positive tone on the open – let’s see.

Rates

Rates had a fantastic day with modst benchmarks around the globe ending the day tighter.

Gilts was where we will focus with the curve steeepening – with the 2 year Gilts -19bps tighter as markets reduced bets that the BoE will need to be so aggressive hiking.

The long end was wider with the 30 year +6bps with the BoE accepting only £22mm of long end bonds in its auction and new 2061gilt expected on Thursday.

10-year Treasuries, Gilts and Bunds yield 3.58%, 3.88% and 1.82% respectively.

The move sub 4% across the curve, as well as the reduced BoE intervention are clearly positives.

Equities

Equities in Europe ended the day in the green. The FTSE was +22bps higher, and European Equities were between+55bps and +157bps higher on the day in Europe.

In the US the S&P, Dow and Nasdaq were up +259bps, +266bps and +227bps respectively.

This morning Europe is opening up +200bps, and the FTSE+100bps. US equity futures are up between +120 and 180bps.

Given the US was recouping Friday’s losses the rally in Europe and the UK does feel like the tail wagging the dog, but we have flagged that positioning has been super bearish and the technical support is definitely there for a move higher.

Today’s Events

Eco

We have Eurozone PPI and Factory orders and Durable Goods in the US

Reporting

None

What Has Caught Our Eye

Currency Swaps Highlight Dollar Liquidity Concerns

Bloomberg posted an article yesterday on cross currency basis swaps – essentially the premium that holders of Euro and Yen need to pay to swap flows into USD spiked with an expectation that this will worsen into year end.

Increased funding costs feed into banks and corporates and make the cost of borrowing in USD more expensive and finding collateral harder.

Whilst basis swap levels are not at Pandemic crisis levels – USD liquidity is being removed from the system and the moves in basis swaps is a symptom /indicator worth being aware of.

“Things could get worse in the next few months,” said Antoine Bouvet, a rates strategist at ING. “If the European
Central Bank goes ahead with QT or if they fiddle with reserve remuneration, we see credit premium rising and this
would contribute to a wider basis.”
Bloomberg , “Year-End Dollar Crunch Fears Show Up in Slumping Currency Swaps”, 03-Oct-22

UN tells Central Banks to Cool Interest Rate Hikes

The UN published its Trade and Development Report yesterday – the main take away being that the Central Bank hiking around the global would have a material impact on Global growth an Emerging Economies, with a soft landing unlikely:

“According to the report, rapid interest rate increases and fiscal tightening in advanced economies combined with the cascading crises resulting from the COVID pandemic and the war in Ukraine have already turned a global slowdown into a downturn with the desired soft landing looking unlikely.
In a decade of ultra-low interest rates, central banks consistently fell short of inflation targets and failed to generate healthier economic growth. Any belief that they will be able to bring down prices by relying on higher interest rates without generating a recession is, the report suggests, an imprudent gamble.
At a time of falling real wages, fiscal tightening, financial turbulence and insufficient multilateral support and coordination, excessive monetary tightening could usher in a period of stagnation and economic instability for many developing countries and some developed ones.”
UNCTAD, “The Trade and Development Report 2022”

The report can be accessed here.

Below are a couple of charts that I thought were particularly interesting.

Credit Market Daily #29