Credit Market Daily #58 %author %

14-December-2022

Good Morning!

The focus on CPI continues but will be overshadowed by the Fed today and the BoE and ECB tomorrow.

Yesterday US CPI came in softer than expected +7.1% YoY, +0.1% MoM vs. +7.3% and +0.3% respectively.

This initially saw equities rally 2.5% before giving some of their gains to end up, but between +30bps to +100bps.

UK CPI has also come in softer than expected this morning +10.7% YoY, +0.4% YoY vs. +10.9% and +0.6% expected.

What does this mean for credit?

Firstly the softer CPI prints should give central banks the ability to step down rates, as expected. Inflation remains elevated and so rate hikes will continue.

The pace of hikes and the pace of a step down to 25bp hikes and pause in hikes will now be front and centre of most investors’ minds.

Central banks have some room to assess the impact of their accelerated hiking cycles at the same time, and being data dependent, will likely say the existing data is supportive of a step down to 50bp hikes.

They will need to see more data before a step down in the size of further hikes is guaranteed.

Post the US CPI the market meme remains for a US recession.

In the UK a recession is a given.

The length and depth of any recession will be impacted by how aggressive Central Banks are. Europe’s situation sits between that of the US and the UK.

However – with inflation rolling over a “soft landing” in the US is being murmured about.

Markets are currently pricing in rate cuts in the US at the latter end of 2023.

Terminal rates are going to have to sit above inflation, full stop, for Central Banks to declare victory, but, if the inflation rollover accelerates there will be some pull forward in the timing of the cycle.

US OIS rate expectations – Lower post CPI, still pricing cuts in Q3/4 ’23.

Lower front-end rates may mean that overall yields could allow credit spread widening in a recessionary environment to occur without seeing overall yields increase significantly.

Longer duration should also perform post any peak in rates. Near-term if credit spread curves flatten, long-duration IG could outperform short on a relative spread (hedged) basis.

For High Yield – relative value and fundamentals will become ever more important in avoiding loss.

Overall a soft landing in the US would be a Goldilocks scenario for US credit.

In the UK and Europe, it is hard to see credit spreads not being pressured by the weaker economic environment.

Investment Grade – given its much lower default probabilities and interest rate sensitivity, should outperform High Yield.

The “soft landing” meme may gather steam but post yesterday’s US CPI print.

Powell’s preferred yield curve measure inverted further – so even the US may not escape a repricing of risk.

Powell’s curve inverts further after CPI print

Last week we pointed to this as a reason for the FED most likely to be heading for a 50bp hike and whilst it also helps the case for smaller hikes in 2023, an outright recession in the US will be negative for risk assets.

Net-net, credit spreads remain likely to widen from here in the first half of the year especially given the rally we have enjoyed in the last 6 weeks.

Positioning remains such that buying will likely bring out more buyers given high cash positions near term.

Fundamentals will be the key driver of spreads in H1 2023 and the pace of the decline in corporate earnings will be what moves equity markets beyond the central bank watching and expecting a return to QE.

Credit should then reprice with equities.

Credit

High Yield

Yesterday’s US CPI saw High Yield credit perform with spread tightening seen across all three indices.

US HY outperformed its GBP and EUR peers and with its total return on the day comparable to the moves seen in equities and slightly outperforming US Investment Grade.

Spread moves for GBP, EUR and USD High Yield indices were -4bps (Z+709 bps), -3bps (Z+521 bps) and -9bps (Z+458 bps).

Xover outperformed c-20bps on the day to 439.

Leaders and Laggers

Investment Grade

Investment-Grade’s performance was predominantly rates driven yesterday with GBP IG underperforming,-13bps, and US IG outperforming +67bps.

In terms of spread performance GBP, EUR and USD Investment Grade moved -1bp (Z+200 bps), +1bp (Z+177 bps) and +0bps (Z+131 bps)

Looking at performance across tenors the belly of the curve outperformed in Europe whilst in the US long-dated bonds performed the best.

Rates

Rates gave back some of their initial rally post the US CPI data. Gilts underperformed on a relative basis given the continued supply in the market as the BoE sells its emergency holdings.

Given this morning’s CPI print in the UK Gilts are likely to rally somewhat.

The 10-year USD, GBP and EUR benchmarks yield 346bps, 329bps and 188bps respectively.

Equities

Yesterday saw stocks react positively to the US CPI print, with the S&P touching +2.5% before equities across the board pared their gains.

This morning’s UK CPI print should be supportive of equities but ultimately where we end the week is dependent on Central Bank messaging over the next 2 days.

Equity futures at the time of writing are down around -30bps in Europe and the UK and +10bps in the US.

Today’s Events

Eco Data

Today’s Reporting

Boparan

Maxeda

Tui

Credit Market Daily #58