Credit Market Daily #51

10th-Nov-2022

Good Afternoon and welcome to CPI day – we are a little later in the day as I figure we can wait until the CPI number is out to give a quick gauge of where we are likely headed between now and the next Central bank cycle

The CPI is 0.4% MoM vs. 0.6% expected and on a YoY basis came in at 7.7% vs, 7.9% expected, and is being taken very positively by risk assets.

That said, 6 FOMC members are due to speak today so we will no doubt have a variety of opinions being seized upon by the equity markets against the backdrop of the CPI print.

Overall this could be the “end of the beginning” – i.e. the Fed may have some room to manoeuvre. Whether it warrants the 3.5% rise in SPX futures is unlikely IMHO – so let’s see where we settle.

Given the time gap between now and the next CB meetings, this bear rally may have legs despite my calls for its demise.

BankNext Meeting Date
FED14th-Dec-22
ECB15th-Dec-22
BOE15th-Dec-22

So – it’s been 2 days since we last published and not a whole lot has happened in that time frame.

The largest event is the US mid-terms which could drag out until Dec 6th when any Georgia Runoff vote would be decided.

I have seen a lot of charts being bandied around -” the market typically rallies after midterms” the “Santa rally is coming”.

Maybe it is – but I suspect it will depend more on the CPI print than the Midterms hobbling fiscal policy in the US.

Overall the market performance looks to have been mixed over the last 2 days, which is not surprising given the level of conviction.

Elsewhere – FTX the crypto exchange has gone belly up and cries of “the emperor has no clothes” have gone up with the corresponding fall in crypto assets as people begin to question the value collateral provided by said crypto.

This Tweet sums it up neatly.

How is this relevant to credit I hear you ask?

I think it is relevant because a lot of crypto is emblematic of the excess animal spirits in markets and benefitted from the massive boost in liquidity provided by central banks post-Covid

In short, it is a relatively fat canary in a coal mine in which more canaries are beginning to sing as liquidity tightens and asset classes have their mettle tested.

I am not in the “this is the end of crypto” camp because I do think it has a place in the world (as do central banks) but when a large and new asset class takes a dunking you should pay attention.

Gilts, Crypto – the list will be longer in the next 12-24 months as higher rates bite into asset valuations – Housing anyone?

Away from the FTX Debacle /Binance Rescue of FTX there were a couple of Bloomberg articles written by Dan Hanson that I wanted to flag.

The first “Why Markets Are Ignoring BOE Message On Rates” looks at why markets are continuing to price a higher terminal rate despite the BoE’s explicit signposting.

TL/DR, Mr Hanson sees 3 reasons:

  • The MPC is underestimating inflation (see chart below)
  • Previous MPC projections were much lower than the current projections and at the time they suggested that market pricing would be too high.
  • UK Rates are being dragged higher by the FED, with a weaker pound being inflationary.

The second article looks at the possible impact the November 17th statement would have on the trajectory of UK rates.

Here the takeaway is the more heavy lifting the UK government does and the amount that is front-loaded will likely mean a lower peak in the terminal rates.

I have to say I am most convinced by the scenario where the Government “goes big” announcing £45bn of fiscal consolidation to 2025.

I think this is a government that has a point to prove and as such, they will want to at least appear to be on the front foot.

Big Picture wise UK credit still faces a recession and consumers are unlikely to cheer fiscal prudence unless the government can find a way to shield individuals.

So – I continue to think UK rates should be lower, and this decline in yield will be offset somewhat by a rise in credit spreads.

“CPI Inflation Has Surprised”
Source: Bloomberg “Why Markets are Ignoring BoE Message on Rates”
“Consolidation Creates Rate Uncertainty”
Source: Bloomberg “Here’s How the Budget Could Alter BoE Policy Path”

Credit

High Yield

Spread performance over the last 2 days was reasonably negative.

The EUR, GBP and USD High yield indices were +2bps (Z+575), +15bps (Z+757), +27bps (Z+511) respectively.

Xover moved +14bps to 529 underperfroming cash and well in from wides of 670 seem in September.

Despite the heroic rally, Xover has experienced it is still cheap when looking at its ratio to the Itraxx Main index, I had said Tues that I thought the meat of the move in Xover is done, and I still do but this shows that there might be a little ways further to go.

Leaders and Laggers

Investment Grade

In Investment Grade credit spread performance was more mixed with the EUR, GBP and USD moved-1bp (Z+211), -2bps (Z+227) +2bps (Z+152) respectively.

The Itraxx Main widened+3bps to108bps and remains cheap to the Senior Financials index something we have flagged as likely to persist.


Rates

Rates have had a soft couple of days with yields moving modestly higher and have reacted positively to the lower-than-expected CPI print with most bonds -13 to -15bps.

The 10-Year Treasury, Gilt and Bund yield 391bps, 330bps and 202bps.


Equities

Are off to the races after a mixed couple of days.

Futures post CPI SPX +2.8%, Dow Jones +2.9% and Nasdaq+3.8%

Again – I think the print is positive but not that positive – big swings, either way, continue to be a sign of a creaking market IMHO.


What Has Caught Our Eye

Fitch – European High-Yield Market Insight Q3

This is a good reference guide for those who are interested – it looks at issuance, defaults and distressed bonds in the European HY market.

A good watch list for names that may get into trouble in the coming 12-24months.

Fitch expects the European High Yield Default rate to peak this year at 1.5% and 2.5% by the end of 2023, for context, they estimate the current trailing 12-month default rate at historic lows of 0.4%.

Looking at the quote below you can see why:

“The distressed ratio, measuring bonds that trade below 80 % of par, surged to 20 .6% in September 2022, from a record low of 0.6% in December 2021, surpassing the pandemic-peak distressed ratio of 15 .1%at April 2020 and nearly matching the distressed ratio of 20 .9% in October 2011, during the eurozone crisis. The all-time high for the bond
distressed ratio was 58 % in March2009″

Fitch, European High-Yield Market Insight

OakTree – Performing Credit Quarterly

The Quarterly for Q3 came out in October but is still relevant and you can subscribe directly here.

It’s a great insight into how one of the “OG” credit firms is looking at the credit market – there is a US bias but overall the authors provide a lot of insight into what they are looking at and why and where they see opportunities.

They single out High Yield bonds – BBs specifically as the sweet spot in the leverage finance space:

“Moving forward, we believe these combined characteristics – minimal credit risk, limited near-term debt maturities, stable borrowing costs, and a low dollar price – will make the BB-rated segment of the high yield bond market appealing to investors. As we articulated earlier, fixed-rate assets have performed poorly in 2022 because duration has been the main protagonist in this year’s credit market drama. But we believe this situation may change if the U.S. economy continues to slow and concerns about credit risk begin to take center stage”

Arman Panossian, Danieller Poli, Oaktree “Perfroming Credit Quarterly”

Some Tweets -UK construction and Housing, China Lockdowns Increasing, Summary of US earnings.

Performance

High Yield

Investment Grade

Rates

Equities

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