Credit Market Daily #37

Good Morning!

A very positive day for risk assets yesterday.

Jeremy Hunt’s statement yesterday was comprehensive in his destruction of the mini-budget, exceeding market expectations.

4 Weeks in the Gilt Market – Hunt’s statement saw the belly rally:

The most interesting part of Hunt’s statement for me was that the energy price cap for consumers will be reviewed in April next year, not 2024, and likely any continuation from April would be targeted and means-tested.

So through April household finances are likely to continue to have support, and the associated inflationary effects will remain baked in.

After April, the medium-term impact implied by the “mini-budget” meant higher, but moderate inflation throughout 2023.

This along with the BoE aggressively front loading of rate hikes is now questionable.

Indeed, looking at the market implied policy rates Pre BoE intervention vs. Post Hunt, rates are expected to be lower, although the implied change in pace is not as discernable.

Add to this a round of spending cuts in the region of £28bn needed (see “What Caught Our Eye”) and growth in 2023 is going to be even more negatively impacted.

Net-net the Bank of England has less pressure to hike aggressively and tomorrow’s CPI will be the main factor determining their pace.

Headlines this morning talk of the Bank of England holding off its planned £80 QT programme which was due to restart next week.

This is positive for sentiment and shows that the BoE wants to ensure any market calm is not challenged.

So – a credible performance from Hunt and supportive noises from the BoE should help risk assets.

Will the markets push for Truss’ exit?

Given the scope of Hunt’s changes, I think it is less likely than yesterday. But go she will and it will be up to the ruling party to ensure any transition is not perceived as chaotic.

Using yesterday’s charts’ data as a baseline we can get a sense of what the “UK Fiscal Fiasco Factor” is.

Overall UK risk compared to German risk looks like it has some way to go in terms of moving towards the 5-Yr average and remains elevated. Compared to Italian risk the UK differential has declined even further.

So – an improvement with some way to go before the lack of Truss in the UK markets is completely reversed. (see what I did?)

Measure (bps)	Fri 14th Oct	Mon 17th Oct	Change	Spread 5-Year Average	Current Spread Z Score
UK CDS – German CDS Spread	15	14	-1	5	5.67
10 Yr UK Gilt – 10 Yr Bund Spread	199	170	-29	99	1.21
10 Yr UK Gilt – 10 Yr BTP Spread	-45	-68	-23	-60	-0.4

Let’s see what Wednesday’s CPI print brings.

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Credit

High Yield

The move in Sterling High Yield was not as momentous as the move in Gilts yes, yes – credit vs. rates, lower duration etc, etc.

But there is more to it.

GBP high yield credit spreads actually widened by +19 bps to +788bps and the wides of the year.

Yield-wise indices declined +17bps, implying the risk-free rate was lower by 36bps.

Given we are looking at indices, I would argue that credit spreads may catch up with the move in rates as there can be a lag and some investors may feel like nibbling at risk.

As mentioned above, UK growth may be the casualty of the policy u-turns and this in turn will hit UK PLC’s profits which in turn will reduce credit quality.

Further, the cost of borrowing for corporates is only going to get more expensive over the medium term. So perhaps the move in spreads is not as counterintuitive as it seems.

UK HY has a high concentration of consumer-led names and with the government talking about being more measured in its spending and support the outlook probably got tougher.

I think we will have to wait until post-CPI to get a real understanding of how UK High Yield credit risk has reacted.

The European High Yield Index spread was flat at Z+623, its yield -2bps to 8.94%.

As expected given the move in stocks, beta outperformed with the single B index returning +27bps on the day, BBs +15bps and the whole index +17bps on the day,

Again – note the lack of a spread move given the reduction in systematic risk.

The Itraxx Xover tightened -10bps to 594bps on the day outperforming the cash indices and dipping below 600. Given the level of basis (Xover spread – Cash spread) this is somewhat expected and may point to the size of that catch-up move in cash should it emerge.

Leaders and Laggers

In single names, Matalan outperformed post its results up c.14pts to 93 as its restructuring process moves forward investors seem to think the business has value and can be sold.

Investment Grade

Sterling Investment Grade, as you would expect, thoroughly enjoyed the moves in the Gilt market, with the GBP Index returning 253bps on the day.

Spread wise the movement was muted, -2bps tighter on the day to 251bps. Again I think there is some lag to this and we should see some catch-up, but the credit response to a material reduction in a UK-specific risk is lacklustre.

Given the amount of newsflow, the twists, turns and u-turns perhaps investors are happy to sit on their hands and wait for the dust to settle.

European and US Investment Grade posted positive returns on the day, high rated, long-duration bonds outperforming.

Credit performance was a small component of their total return the European and USD indices moving +1bp (233bps) and -0.5 bps (164.5bps) on the day.

There was little corporate issuance with FCA bank bringing €800mm across 2 tranches – both were well recieved.

Sovereign, agency and sov-linked issuance dominate but with the move lower in rates and a window of calm we should see more corporate issuance I think.

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Rates

The 10-Year treasuries, gilts and bunds yield 401bps, 399bps and 231bps.

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Equities

Yesterday was a strong day in equities with all regions in the green, this morning is a continuation of the same.

Earnings season in the US has kicked off, here are this week’s S&P 500 reporters:

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Today’s Events

Eco Data

We have the German ZEW Consumer Sentiment survey -66.5 expected, previous -61.9 and US industrial production.

Today’s Reporting

Netflix

Pierre & Vacances.

Metalcorp Bondholder Call

What Has Caught Our Eye

Fixed Income, Bonds Are Becoming a la Mode

The outlook for bonds as an asset class is improving. “TINA” no more!

This video (also a podcast) from the Macro Trading Floor sets out why as does this article from Real Investment Advice – they coin the quirky “BAAA” acronym – “Bonds Are An Alternative” (see quote and chart below).

“an investor can buy a ten-year U.S. Treasury note at 3.95%, which is better than the average of the three expected stock returns. Further, an investor can take some credit risk and earn nearly 6% on investment-grade corporate bonds. Doing so would easily beat expectations for stock returns.”

Michael Lebowitz, RIA, 12-Oct

Mind the Gap – Hunt’s Hunt for Funds

This article in the FT sets out the challenge Hunt faces in balancing the UK books. Cuts are expected with some thinking the UK govt will have to over-tighten on the Fiscal side of things to win back market confidence.

Worth a read.

Performance

High Yield

Investment Grade

Rates

Equities