Credit Market Daily #61 %author %

19-December-2022

Good Afternoon!

A quick look at asset class performance last week. Last week there was a whole host of data out from the Bank of England and we cover it in “What Caught Our Eye” below.

Overall risk-off across most regions and asset classes with the US bucking the trend in rates and Investment Grade credit.

GBP assets outperformed their European peers, likely reflecting the less Hawkish messaging of last week’s meeting.

The Itraxx Crossover index breezed to our Jan target of 500 over Thursday and Friday.

It was 437bps on Wednesday and ended Friday at 506. In price terms that is roughly a total return of c.-273bps.

Which compared to the total return on the week for EUR HY points to material underperformance vs. cash bonds.

This is unsurprising given most of the market is out and Xover is the hedging instrument of choice.

Cash should follow suit in an illiquid market if the sell-off in equity gathers pace and given the lack of market participants could result in some gappy price action.

Otherwise, I think we will remain range bound with market participants returning in January to reduce risk given the Bear Market Rally.

Asset Class	EUR	GBP	USD
High Yield	-41 bps	-8 bps	-11bps
Investment Grade	-114 bps	-21 bps	+52 bps
Equity*	-279 bps	-119 bps	-299bps
Rates**	-198 bps	-123bps	+106 bps

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

Credit

High Yield

Xover is opening c.-10bps in line with equities at 496 bps. Today’s equity move, likely decided by the US, should either see us range-bound or set us up for a sell-off this week.

As mentioned above cash has yet to underperform and signs of weakness persisting in the equity market are likely to be the biggest catalyst for bonds to get marked down.

Liquidity is likely to be such this week that any moves (either way, but in particular down) will be exacerbated.

GBP, EUR and USD spread moves were +2 bps (692 bps), +5 bps (505 bps) and +10 bps (475 bps) respectively.

Leaders and Laggers

Investment Grade

Investment Grade outperformed High Yield and Equities on Friday with total returns reflecting the move seen in rates.

USD IG outperformed in total return terms, whilst GBP IG was the laggard on the day underperforming having outperformed earlier in the week.

GBP, EUR and USD spread moves were +0 bps (193 bps), +2 bps (173 bps) and +1 bps (133 bps) respectively.

Rates

Friday saw bond yields in Europe and the UK.

In Europe, the Bund-BTP spread continued to rise and I think that this is only going to continue until the ECB comes out with more detail as to how they will manage the widening gap.

In the UK the Gilt curve flattened further.

In the US treasuries steepened on Friday.

This morning UK benchmarks are sider by around 5/6bps across the curve. Bund and US treasury curves look to be steepening with longer-end rates underperforming the front end.

10-year Gilts, Bunds and Treasuries yield 337 bps, 216bps and 351bps respectively.

Equities

Equities continued their sell-off on Friday and are currently trading c.+30 to +60bps in the UK and Europe.

US Futures are up around +40bps and I would expect the US to decide the direction of performance this afternoon.

Today will likely be somewhat of a test, if we can end green then we should remain range bound but a continued leak wider does not bode well for the rest of the week IMHO.

Today’s Events

Eco Data

This week we have German IFO sentiment, US housing starts, German Consumer confidence, US and UK GDP and the US leading indicator.

UK GDP is expected to confirm a recession and the focus will be on how deep/shallow the reading is compared to the -0.2% expectations.

Today’s Reporting

Alain Affelou

What Has Caught Our Eye

Bank of England: MPC

The Bank of England MPC saw rates rise 50bps, with members somewhat split (1 vote 75bps, 6 votes 50bps and 2 votes for no hike).

The split in voting intention was taken by some to suggest a higher probability of lower hikes in the coming months.

My own take is that as consensus is reduced, guessing the MPC’s reaction function to economic data unless significantly higher or lower than expected becomes harder, and the potential market impact larger.

Many a headline was made on Bailey’s comments that inflation may well have peaked, despite inflation being expected to remain above target in ’22/3

The labour market, wage inflation, and food and energy prices were flagged as upside risks for inflation, with energy expected to moderate in ’23 as the effect is annualised.

Main takeaways:

CPI to remain high and fall sharply from mid-2023, driven by energy, economic slack and unemployment
CPI to fall some way below 2% target in ’24, ’25
Risks to the upside for inflation – domestic wage and price pressures remain elevated.
Supply chain bottlenecks easing across most indicators. China’s opening with COVID is a risk to this.
Food and non-alcoholic beverage price inflation was 16.4% in November, the highest in 45 years and is expected to increase.
BoE staff expect a 0.1% decline in GDP for Q4 ’22
Expect a “slight fall” in GDP in Q1 ’23
Credit availability reduced – seen in mortgage approvals declining to the lowest level since 2009
Zoopla – current housing market data shows offers being made are below seasonal expectations
BoE has sold 40% of the Gilts it bought as part of Financial Stability operations conducted between the 28th Sep and 14th of October
The labour market is “historically very tight”, uncertain how quickly this recalibrates downwards in line with the economy.
Private pay grew +6.9% +0.5% higher than expected for November and is expected to flatten at 7% before declining later in 2023.
No Comment on the gap between market and BoE rate expectations.

Bank of England: Market Participants Survey

The Market Participants ran from the 30th of November – the 2nd of December ’22 and aims to understand inflation and interest rate expectations of the market.

Overall market participants are expecting the BoE rate to peak at 4.25% vs. 4.5% expected at the November BoE meeting.

Overall participants see the neutral rate at 3%, with 10-Year gilts currently expected to peak around 3.5%

Inflation expectations have declined significantly between the December and November meetings (see below):