Credit Market Daily #59 %author %

15-December-2022

Good Morning!

Yesterday we spoke about what a faster-than-anticipated rollover in inflation could mean and the headroom the CPI prints bought Central Banks.

Yesterday’s FOMC saw rates higher by 50bps, but there was a distinct hawkish tone.

We cautioned yesterday that “They [Central Banks] will need to see more data before a step down in the size of further hikes is guaranteed.”

This came from the position that Central Banks have stated they will err on the side of overtightening vs. allowing inflation to get out of control.

Yesterday’s FOMC presser was another case of expectations meeting reality and ultimately sets the market and the FED at odds as to the path of rates and the likely impact on the economy.

The “Soft Landing” market meme suffered a setback yesterday,

The main things I took away from the presser (see below for the video) were:

An increase in both the expected Fed Funds Peak and Core PCE Inflation 5.1% vs. 4.6% prev and 3.5% vs. 3.1% prev, respectively
Powell spoke to financial conditions – the markets – as not being where they should be i.e. looser given the rally
Jobs data is still too hot and there needs to be a decline in employment
Market pricing of rate cuts in 2023 -this is not on the cards, PCE is still above 2% target in 2024.
Rates will need to remain restrictive for a sustained period after hiking finishes, with a further 75bps hiking implied
The FOMC committee felt they had yet to get a grip on inflation

Higher Rates, higher inflation, lower growth, PCE still above 2% target in ’24

So – the set-up is this, the Fed currently (and this is important to stress, given they have been caught wrong-footed) sees higher terminal rates, inflation and no rate cuts in 2023.

The market sees inflation rolling over, a potential recession and rate cuts.

“Don’t Fight the Fed” – was the refrain during QE and it should remain the same now.

Net-net Powell’s presser was intended to cool the market’s heels and also communicated uncertainty on the FED’s part as to just how much of a grip they have on inflation.

They are very much in “wait and see mode” and further 50bp hikes are not off the table.

The majority of FED Reserve members see a terminal rate above 5%

Overall I think that the FOMC’s meeting should garner weakness in risk assets in the near term, but that we continue to see any declines in CPI and employment as seized upon as reasons to rally.

At some point, the meme will need to change from “good news is bad news” to “bad news is bad news” but we are some way off that with the hiking cycle yet to be completed.

Any signs that central banks will overtighten will be met with a serious bout of risk off.

Given Credit valuations are fair at best, I think there could well be some profit-taking in the new year between CB meetings.

It still pays to be defensive in sector allocation, seniority and duration but valuations mean that the relative value between issuers is important.

In the meantime, for the FED at least, employment numbers are the ones to watch.

We have the Bank of England later – here they have been telling the market that rate expectations have been too high. It will be interesting to hear what they are thinking about the hiking cycle and if they make any adjustments to their forecasts.

They will likely err on the side of caution in their messaging but the current expectation/ guidance gap is not as large as with the FED.

As for the ECB, their messaging has been so poor with walk backs by Legarde that I hope they are more concrete in their messaging.

Credit

High Yield

It was a relatively flat day in High Yield yesterday with indices posting small but positive total returns.

GBP, EUR and USD index spread moves on the day were -1bps (Z+683), -1bps (Z+506) and +3bp (Z+451)

Xover was -2bps tighter on the day and is opening 8 wider this morning at 446.

We could well see this touch at least 500 into January I think if markets look to take profits and position more conservatively.

Leaders and Laggers

Investment Grade

Investment Grade’s Total return yesterday was flat in GBP and EUR with the US index outperforming up +17bps on the day.

GBP, EUR and USD index spread moves on the day were -3bps (Z+193), -2bps (Z+172) and +1bp (Z+130)

The Itraxx Main index ended the day -1bp and is opening 2bps wider c.85 bps.

Rates

UK and EUR rates ended the day relatively flat yesterday, whilst treasuries were slightly higher after the Fed.

The 10-year UK, EUR and US benchmarks yield 330 bps, 193 bps and 350 bps respectively.

Equities

Equities ended the day in the Red in Europe and the UK ahead of the FED and despite the decline in the UK CPI.

US equities gave back gains and also ended the day lower post the FED meeting.

We have the ECB and BoE later today and Equity futures are currently pointing to Europe opening up c.-60bps, the UK -30 bps and the US down c. -20bps.

Today’s Events

Eco Data

Today’s Reporting

Ceconomy

Energo-Pro

What Has Caught Our Eye

FOMC Press Conference

Despite the slowdown in growth, the labor market remains extremely tight, with the unemployment rate near a 50-year low, job vacancies still very high, and wage growth elevated……In November, the 12-month change in the CPI was 7.1 percent, and the change in the core CPI was 6 percent. The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases. But it will take substantially more evidence to give confidence that inflation is on a sustained downward path
Jerome Powell, 14-Dec-22

Credit Market Daily #59