Credit Market Daily #31 %author %

06-October-22

Good Morning!

Markets were mixed, with high yield outperforming yesterday.

Opec+’s announced production cuts buoyed oil prices, with the announced 2mm bpd cut roughly equivalent to 2% of global production.

However, the real-world impact is expected to actually be around half that at 1m to 1.1m bpd, with a number of countries failing to make their production quotas in the first place.

Goldman Sachs (see video below) expects brent to hit $110/ barrel with current prices already reflecting weak economic growth.

This increase in price will be unwelcome given the recent recovery in pump prices and markets’ hopes for an easing in inflation.

Away from that, Fed member Raphael Bostic spoke saying that he favoured a hike in rates to 4-4.5% by the end of the year and holding them there to see how prices react, keeping his messaging hawkish, markets continue to look for signs of a pivot.

Despite “glimmers of hope” in recent data, Bostic said “the overarching message I’m drawing…is that we are still decidedly in the inflationary woods, not out of them,” with the Fed’s target funds rate needing to rise to around 4.5% by the end of the year.
Reuters, Fed’s Bostic says inflation fight “still in early days”,5th -Oct

UK grocery bellwether Tesco’s reported H1 numbers yesterday with LfL sales beating expectations and the company upgrading its FCF forecast for the full year on the back of working capital inflows and cost cutting,

The company narrowed its full-year profit guidance from £2.4bn to £2.6bn to £2.4 to £2.5bn, with comments on “significant” cost inflation and uncertainties in the external environment.

Equity declined 3.8% and whilst credit was relatively flat.

Tescos is cutting 325 head office jobs at the same time as raising wages for the third time in 13 months. The head office cuts are in the context of 500 head office vacancies so the net change in headcount looks to be positive, but allows cost savings.

The uncertain outlook and laser focus on cash flow highlight the challenge, particularly in the retail sector (see “What Caught Our Eye” below).

Tescos actions also demonstrate the credit positives that can come out of periods of stress with a focus on cash flow and operational efficiency.

Sticking with retail, City A.M reports that UK footfall for September remains -17.4% below 2019 during the week and -6.9% during the weekend over the same period.

Sequentially footfall is up +6.8% vs. August but the pace of growth slowed for the third month in a row.

In Gilts the Bank of England rejected all offers in its auction to buy long-dated Gilts again, putting a bit more pressure on the long end of the curve.

There appears to be some price discovery as to when the Bank will buy, at the same time the moves higher in yields are not panicked and the market clearly understands the BoE is there if needs be.

We have a week until the BoE removes this safety net.

The FT reports that banks and asset managers are benefitting significantly from pension funds looking to raise cash and shore up positioning with secondary markets in Private Equity trading at 20-30% discounts.

Fitch joined Standard and Poors in putting the UK’s AA rating on a negative outlook for downgrade – the government and bank of England still have some work to do.

Finally yesterday’s composite PMIs for Europe, the UK and the US all printed sub 50 in the contractionary territory with France the only country to print above 50.

Credit

High Yield

European High Yield outperformed equities, investment grade and its CDS equivalent yesterday, returning -4bps on the day. In spread terms, the index tightened -9bps to 607.

It was a similar story in Sterling and Dollar high yield with the indices returning -6bps and -5bps on the day respectively.

In spread terms, the Sterling high yield index tightened -8bps to 696bps and Dollar high yield index tightened-12bps to 513bps.

Xover underperformed, +1bps wider on the day back above 600 to 607bps, with the basis between XOver and cash widening again.

Primary is in focus with Elon Musk’s Twitter deal adding c. $12.5bn to a pipeline of debt that banks will have to syndicate into a market that is favouring vanilla known names.

Spanish retailer Tendam Brands (B1/B+) is in the market with a lev loan-like €300mm Senior Secured 5.5year Non-Call 1 floating rate bond in order to partially refinance existing debt. Price talk is Euribor 750-775bps, the bonds being taken out had a coupon of 5%.

House of HR’s foray into the primary market has been postponed.

Access to capital is not a given.

Leaders and Laggers

No real news in terms of movers – names that have been out of favour continue to drift lower, whilst higher beta names recouped some of their recent losses

Investment Grade

European, Sterling and Investment Grade Credit returned -72bps,-101bps and -64bps on the day respectively, underperforming High Yield and Equities driven by rates.

In spread terms European, Sterling and Investment Grade Credit spreads were all +2bps wider on the day.

New Issuance came back with a bang to European markets with 11 investment grade issuers bringing €13.2bn of bonds to market.

The most noteworthy was EDF (Baa1/BBB/BBB+) which came with a €3bn 3 trance deal – €750m 4-year, €1bn 7-year and a €1.25bn 12-year.

All 3 tranches were priced 10-25bps tighter than guidance and with books c1.5-2x.

Rates

Gilts were wider in the face of no BoE purchases, with the long end underperforming.

Treasuries came under pressure with the ISM services index coming in ahead of expectations but ended the day flat.

In Europe, bunds were wider across the curve.

The 10-year Treasury, Gilt and Bund Yield 378bps, 403bps and 205bps respectively.

Equities

Equities in Europe ended the day down c-100bps, and the FTSE was down -48bps.

The US saw equities pare losses into the close and the S&P 500, Dow Jones and Nasdaq returned -20bps, -25bps and -14bps respectively.

At the time of writing futures point to a reversal of yesterday’s losses.

Today’s Events

Eco Data

German Factory orders missed -2.4% vs. -0.7% expected. We have UK and German Construction PMIs, European retail sales and jobless claims in the US.

Today’s Reporting

Levis

What Has Caught Our Eye

European Distress Index – UK weak, defaults to rise

Weil published their monthly European distress index which showed corporate distress rose to its highest level since Sept 2020.

UK corporates showed the highest level of corporate distress with Germany taking second place.

The index looks at corporate liquidity, profitability, risk, valuation, investment and financial market factors in order to come up with its assessment.

“The latest data shows that corporate distress was pushed higher by weaker investment metrics, pressure on liquidity and a deterioration of
market fundamentals
Support from valuation metrics have also waned recently to their lowest level in over three years”.
WEDI Distress index

The full report can be downloaded here and is well worth a read. We have picked out a few charts of interest below:

The Index looks to be a reasonable leading indicator of defaults

The retail and consumer-led sectors are, unsurprisingly, the most distressed:

Financial Services and Commodities are the least distressed:

IMF thinks Wage-Price Spiral is contained

Link to article here.

It is interesting to see that the IMF believe inflationary wage growth should be contained.

Tesco’s experience of giving its employees a third pay rise in 13 months is anecdotal and paints a different picture.

I flagged the large increase in the German minimum wage that is coming into effect this month c.12% in real terms.

So this article is a counterpoint that points to wage growth being contained and that it may not eat into corporate margins.

The IMF finds that on average wage-price spirals are rare and it believes that the current environment of central bank tightening should keep wages in check.

“Three factors are working together to contain the risks [of a wage-price spiral]: the underlying shocks to inflation are coming from outside the labor market, falling real wages are helping to reduce price pressures, and central banks are aggressively tightening monetary policy.”
Wage-Price Spiral Risks Appear Contained Despite High Inflation, John Bluedorn, IMF, 5-Oct-2022

“real wages tend to go down initially as inflation outstrips wage growth, helping offset some of the cost-push shock that fueled inflation and working against a wage-price spiral. But if inflationary shocks start to come from the labor market itself—such as an unexpected, sharp uptick in wage indexation—that could moderate the effects of falling real wages, pushing up both wage growth and inflation for longer”
Wage-Price Spiral Risks Appear Contained Despite High Inflation, John Bluedorn, IMF, 5-Oct-2022

Credit Market Daily #31