Credit Market Daily #38 %author %

20-Oct-2022

Good Morning!

Another 2-day issue, normal service will resume tomorrow.

So What has Changed?

UK CPI came in ahead of expectations
The BoE is not delaying QT
Flirting with Inverting: US 10-Yr, 3-Month Yield
Earnings so far are ok
UK Home Secretary resigns

UK CPI

UK CPI for September came in at 10.1% vs. the 10% expected, with MoM inflation coming in + 0.5%. 7 out of the 12 categories reported higher prices.

Core CPI (CPI excl. energy, food, alcohol and tobacco) stood at 6.5%. This keeps the pressure on the BoE to keep hiking.

The largest impact came from food and non-alcoholic beverages. This is mainly a reflection of a strong dollar, supply and costs inflation pass-through from manufacturers.

The good news is that food prices have been rolling over as flagged by the UN’s FAO, however, prices remain significantly elevated relative to prior years.

Housing and Household services – rents – the sticker part of inflation represented 27.5% of CPI but has been relatively stable with a small but steady increase since April.

The main source of declining inflation was Transport which was predominantly driven by a decline in fuel costs. Looking at the RAC fuel watch prices have recently peaked but have a significant way to go relative to history.

Add to that Opec+’s determination to defend oil prices in the face of slowing growth, and Goldman Sach’s forecast of $100 oil for Q4 and upside surprises, or at least a floor in prices seems very real.

BoE is not delaying QT

Harmonious headlines on Tuesday that the BoE was taking a gentler path and delaying its £80bn (£8bn/month) QT until gilt markets find their feet were repudiated by the Bank.

QT will go ahead but the BoE will only be selling bonds back in the short to medium-maturity buckets, keeping any negative price pressure away from the LDI long end. The bank will publish the dates and sizes of the auctions this evening.

The Gilt Curve reacted with the long-end tightening given the lack of QT supply, with the 30yr Gilt falling below 4% for the first time since the 4th of October.

US 10yr – 3 Month Curve

As recession indicators go yield curve inversion is one that everyone keeps an eye on.

The most publicised spread is that between the 10yr and 2 yr UST. However, market participants will generally look at a whole range of spreads, with those with shorter maturities tending to have greater predictive power when it comes to flagging recession risk.

Well, the 10yr-3 Month curve is very close to inverting and as you would expect is causing quite a stir as recessions tend to follow within 24 months of the inversion.

Remember – the Fed wants a recession – it will slay the inflation dragon.

With the Fed talking down the probability of a soft landing, the UK and Europe also facing recessionary pressures, as the cycle continues to turn corporate bond spreads should widen.

Earnings Are Ok So Far

Corporate earnings have held up reasonably well in the US with last week’s bank earnings being well received. Netflix surprised on the upside in terms of subscribers, Tesla showed revenue growth but missed estimates.

Proctor and Gamble lowered its revenue guidance given consumers are facing a cost of living crisis and it said it expected the strong USD to hit its bottom line.

The company, like Nestle which also reported a decent set of numbers yesterday, have been able to grow revenues by passing the cost through to consumers.

The Bloomberg interview below is a good window into investors’ thinking.

Results have been ok so far but markets are impatient to see that the bottom is in and find a floor.

Corporate outlooks, how they handle inflation, whether are they seeing lower demand, the stronger USD, slowing economies and weak consumer sentiment are going to be the main driver of near-term returns.

The UK Home Secretary Resigns

The Omni-shambles continued and Gilt markets are currently ok with it.

Truss’ eventual exit will be a positive catalyst. The transition to new leadership may cause a wobble.

But this should crystalise in the coming weeks.

Credit

High Yield

Sterling High Yield saw credit spreads tighten by -11 basis points on Tuesday and then remain flat on Wednesday at Z+777.

For comparison, European High Yield is -17bps tighter over the same period and USD HY was -15bps tighter at Z+522.

So I think there was some catch-up in the spread of the indices on the back of Hunt’s actions, but overall the moves in credit risk appear to have been muted.

Xover having outperformed cash on Monday’s announcements went on to remain flat so that the spread performance Monday through to Wednesday was -17bps and very much in line with Euro cash.

Month-to-date High Yield has returned -2bps, +2bps and +84bps for Euro, GBP and USD high yield respectively.

USD High Yield was favoured over European High Yield for the next quarter in terms of potential returns in our EHYO x BI survey.

The first and foremost reason is the USD denomination of the index and the second reason it is favoured is the high proportion of oil-related companies in the index.

There will be some giveback both in terms of the support from oil and USD when the FED pauses as it will be likely in response to slowing or negative growth.

Leaders and Laggers

Investment Grade

European Investment Grade saw its spread -4bps tighter Monday to Wednesday (Z+229). GBP and USD Investment Grade saw their spreads move -3bps (Z+241) and 0bps (Z+164) respectively.

Month to date EUR, GBP and USD Investmentgrade has returned -64bps, +120bps and +84bps respectively.

The GBP and USD Investment Grade Indices managed to outperform their High Yield Equivalents, with GBP Investment Grade returning +180bps relative to Monday given the rally in Gilts.

In terms of primary – Non-financials returned to the market with Tennet (A3/A- Utility) pricing a 4 tranche €3bn deal which saw overall books 2x the issue size and it priced c.25bps tighter relative to initial price talk.

So Investment Grade primary is open.

Rates

The 10-year Treasury, Gilt and Bund yield 414bps, 385bps and 241bps respectively.

Equities

Yesterday was a soft day in equities with the UK CPI number keeping inflation front and centre.

Today is a continuation, with European and UK equities down and between 0 and 0.5%. US futures are mixed and with no significant Economic data out today will be driven by results.

Today’s Events

Eco Data

German PPI YoY 45.8% reported, 45.4% expected; MoM 2.3% reported, 1.5% expected. French Manufacturing Confidence 103, 100 expected.

In the US later – Philly Fed, Initial Jobless Claims and Existing Home Sales.

Today’s Reporting

IPFLN

DIA

Ineos

Nokia

Tenemos

Travis Perkins

Verallia

Credit Market Daily #38