Credit Market Daily #52 %author %

6th-December-2022

Good Morning! we are back after a much-needed break.

What has changed?

Valuations is probably the largest change in the 3 weeks since our last daily.

The Bear Market Rally has continued unabated and is only now showing signs of slowing.

Central Banks have commented that a slowing of the pace of hikes is warranted, and economic data has continued to be relatively soft.

The “GoOD NeWs Is BAd nEwS” narrative continues – equities yesterday softer given a stronger than expected US ISM or last Friday’s Non-Farm Pay Rolls certainly giving markets pause for thought before the numbers were shrugged off.

The “risk on” environment has seen primary open up with IG well supported and HY able to get selective deals done with extensions of existing deals replacing out refinancings.

Equity valuations remain silly (IMHO) and credit certainly looks as though it has had a lot of the juice squeezed from it.

GBP remains relatively cheap – there has been no catch up which is surprising in some respects and is something to think about.

Perhaps it is a case of “cheap staying cheap” given the economic outlook, but it does look to offer value relative to EUR and US peers in High Yield and Investment Grade.

Looking at the table below US credit has stolen the show – Powell’s statement that the pace of rate hikes would need to moderate providing a foundation for spreads and rates to rally strongly.

As mentioned before the “Pivot” won’t happen and we are months away from a potential “Pause” so as we head into next week’s Central bank meetings the very least we should expect is more volatility, and medium term pressure on valuations should result in repricing of spreads and equities in the face of a weakening global economy.

Can the rally continue? Yes. Is Credit still cheap – no.

Most sell-side strategy favours Investment Grade over High Yield, and expect default rates to be manageable. So overall the refrain remains the same, up in quality, defensive sector and rating positioning.

Given the move in valuations – relative value becomes the name of the game, especially in high yield.

Asset Class moves since CMD #51 Nov-10th

Asset Class	EUR	GBP	USD
High Yield	+250 bps	+232 bps	+272 bps
Investment Grade	+223 bps	+157 bps	+453 bps
Equity*	+246 bps	+38 bps	-30.5 bps
Rates**	+148 bps	+126 bps	+315 bps

Source Bloomberg. * FTSE 250, EuroStoxx 600, Russell 2000. ** 10-year Benchmarks, S&P Current Treasury 10yr TRI for USD

CDS -Xover Remains Cheap vs. Main

Despite the enormous rally in Xover -it was 529 when we last wrote – now c.456 bps – the ratio to Main is back above 5x with Main outperforming

Using Z scores to frame Credit’s performance.

Spreads are no longer cheap and bordering on expensive.

US credit Z scores have actually turned negative over the 12-month look back – which puts them on the wrong side of the average spread.

Euro HY also has negative Z scores for BB and B-rated credit as do AAAs in EUR investment grade credit.

Break-even spreads – Spread / Duration have all declined – there is less spread cushion or protection on aggregate given the rally in across the asset class.

As mentioned earlier GBP credit is the laggard – both in terms of spread performance and break evens, screening cheapest in both IG and HY.

Overall yields are lower but GBP and USD credit remain attractive when compared to equity earnings yields – S&P 500 5.5%, Russell 2000. 2.05%, FTSE 100, 7.7%, FTSE 250 6.47%, DAX 7.59%, Euro Stoxx 600 6.63%.

GBP High Yield RV

EUR High Yield RV

USD High Yield RV

GBP Inv. Grade RV

EUR Inv. Grade RV

USD Inv. Grade RV

GBP HY Breakevens Remain Elevated

Credit

High Yield

Following a strong run last week, cash has stuttered higher, but remains largely unch. on the day. XOVER has opened 7/8ths wider, following a +13.75bp move yesterday.

The EUR, GBP and USD High yield indices were +2bps (Z+509), +3bps (Z+703), and +5bps (Z+460) respectively.

XOVER remains well in from wides of 670 seen in September, following this sharp rally the index has settled around the 460 level, but still remains cheap relative to the Itraxx main Index.

Consternation over weak macroeconomic data from the US & Europe has stifled the markets’ risk-on tone as we head into the year-end, with recessionary outcomes in FY23 becoming increasingly likely. As such, we expect XOVER (HY) to continue to price relatively cheaply to MAIN (IG).

Investment Grade

In Investment Grade performance was more mixed with the EUR, GBP and USD indicies moving+9bps (Z+180), +53bps (Z+203), and -71bps (Z+132) respectively.

The Itraxx Main widened +0.4bps to 90.6 bps and remains cheap to the Senior Financials index.

Rates

Rates are generally opening tighter, with the UK 10 YR -0.2bps, the German 10 YR -1.3bps, and French -2.1bps.

Yesterday, there was a sharper move in the US, where the 10 YR widened by 9.8bps, with shorter maturities widening slightly more.

Overall the US 2yr-10yr spread is now c. -77.2bps, with investors firmly pricing in lower longer-term interest rates, as the likelihood of a 2023 recession sits front of mind.

The 10-Year Treasury, Gilt and Bund yield 357.3bps, 308.6bps and 185.8bps respectively.

Equities

European equities have opened largely unch., with a small negative move in the Euro Stoxx 600 (-0.02%), and the FTSE 100 -0.1%.

American markets gave back some ground with the S&P 500 falling by 1.79% yesterday evening. Losses were fairly uniform, with slightly more weakness in the energy & consumer discretionary sectors.

Futures on the S&P 500 are slightly green +0.11%

Today’s Events

Eco Data

A mixed bag this morning, but surprising on the upside.

UK BRC November Retail Sales MoM +4.1% vs. +1.2% expected, German Oct Factory orders +0.8% vs. -4% expected, German Construction PMI 41.5 vs. 43.8 expected.

Today’s Reporting

Paragon Group

Credit Market Daily #52