Credit Market Daily #53 %author %

7th-December-2022

Good Morning!

Stocks continued to wobble yesterday ahead of next week’s Central Bank meetings.

As inflation peaks and economic data softens there should be a narrative shift from the “Pivot/ Pause” to one of slowing growth and lower margins. In theory, this should lead to wider spreads and lower equity valuations.

For that to happen “good news is bad news” will need to end.

The strong ISM numbers that gave US equities pause for thought come at a time when yield curve inversion in the US is increasingly recessionary.

Indeed, I looked at Powell’s preffered yield curve measure, the implied 3 month T-bill yield in 18 months less the current 3 month T bill yield and it has indeed turned negative since the Fed meeting on the 2nd of November, it touched -46bps on the 1st of December and is currently sitting around -25bps.

Powell’s Yield Curve is inverted – recessions shaded in red

So fears of a 75bp hike may be overdone with Powell’s most recent speech speaking to slowing the pace of hikes, also suggesting a 50bp hike is on the cards and equities are suffering from a lack of conviction.

75bps or 50bps though rates are still going up, despite inflation potentially peaking, we have another 3-6months of tightening IMHO.

Elsewhere, UK house prices also highlight a slowing economy.

The S&P Construction PMI for the UK came in at 50.4 down from 53.2 the previous month, still in expansion territory but the lowest in 3 months.

UK Construction PMI:

Additionally we had the Nationwide and Halifax House price indices both show declines -1.4% and -2.3% for November respectively, the decline in the Halifax survey the largest in 14 years.

We expect this to continue to be a leading indicator of a softening in the UK economy.

Yesterday we looked at where credit stands Relative Value wise given the recent rally and I said that I thought equity valuations still looked too high.

I want to share 2 charts, the first shows global equity valuations and suggests that outside the US valuations are actually more reasonable.

I think it is important to highlight this as the US can steal the focus and we should be looking at the broader picture when it comes to relative value.

The second chart shows that despite the rally short covering may not have been all that extensive in US and coupled with bearish sentiment keeps a key technical intact that supports equity prices.

Which, in the context of “when the US sneezes, the rest of the world catches a cold”, has broader implications for other equity markets.

A clear-out of shorts is needed if we are going to have a proper leg down in equity markets.

Despite the Rally, shorts may not have been squeezed out..

Credit

High Yield

The EUR, GBP and USD High yield indices were -3bps (Z+516), +1bps (Z+709), -28bps (Z+468) respectively.

XOVER opened 1.4bps wider at 466, and is 9 bps wider on Monday’s close.

Overall XOVER remains well in from the wides of 670 seen in September, but there does appear to be a more cautious tone this week as the cost of living pressures & rising rates seeps into economic data.

Leaders and Laggers

Investment Grade

The EUR, GBP and USD Investment Grade indices were +36 bps (Z+177), + 15 bps (Z+201), +51 bps (Z+132) respectively.

The Itraxx Main was tighter this morning by 0.4bps at 91.2 bps

Rates

Rates are generally opening tighter, with the UK 10 YR -2.18bps, German 10 YR -2.5bps, France -2.5bps.

The US 10 YR has tightened by 1.84pts, but rates volatility remains high, with the move index at 129 (covid wides of c.160). The US 2YR – 10 YR remains markedly inverted at -82.7bps.

The 10-Year Treasury, Gilt and Bund yield bps, 305.1bps, 351.3bps and 176.3bps respectively

Equities

European equities opened slightly weaker, but are largely unch. this morning, with a small negative move in the Euro Stoxx 600 (-0.15%), and the FTSE 100 -0.11%.

The S&P 500 fell by 1.44% yesterday and is trading below last Friday’s close of 4,071.7. The S&P has lost money for 59% of weeks this year, making 2022 second only to 1931 for % of down weeks.

Futures on the S&P 500 are slightly green +0.06%

What Has Caught Our Eye

Low High Yield Supply

Bloomberg notes that Barclays and JP Morgan Chase are expecting 2023’s High yield supply to be limited to refinancings with limited “new” high-yield issuance as banks will shy away from funding M&A activity.

The first half of ’23 is expected to be particularly subdued with the second half likely to see more issuance assuming that interest rates and the economic outlook are more favourable.

Yields remain multiples of current high-yield index coupons, making issuers gun-shy.

In a separate story, Bloomberg also reports that this week is likely to be the last in terms of supply for corporate bonds before 2023, with Central banks next week and Christmas fast approaching.

This should be a strong technical for High Yield Cash next year. We look forward to our Q4 High Yield Investor Survey to see how much cash has been put to work over the past few weeks.

Cash on the sidelines was roughly 7% of participants’ portfolios as of Q3.

“JPMorgan strategists forecast gross supply for high-yield bonds by European corporate borrowers next year at €50 billion, while their peers at Barclays are more optimistic and estimate €75 billion. Still, that’s well below the average €91 billion in the five years up to and including 2021, according to data compiled by Bloomberg.”
Guilia Morpurgo, Bloomberg, 6th-Dec-22

Gilts – Too much Supply?

This article from the FT discusses the huge amount of Gilt supply that is coming to the market and perhaps that the focus on the recent balancing of books by the government is misgiven and Gilts could face upward pressure on yields.

“I don’t think the market has quite come to terms with the scale of all of this,” said Craig Inches, head of rates and cash at Royal London Asset Management. “It’s cataclysmic.”
Tommy Stubbington, FT, 6th-Dec-2022

Credit Market Daily #53