Credit Market Daily #62

20-December-2022

Good Morning!

This morning we turn our eyes East to Japan and China.

The Bank of Japan has caused a stir this morning by increasing the range in which it’s happy to allow the 10yr benchmark yield by +25bps.

Yield Curve control remains in place, QE purchases are increasing and Kuroda has said further tweaks to yield curve control are off the table.

So +25bps more headroom in the long end of the curve whilst QE continues doesn’t seem “hawkish” to me but I don’t know enough to fully gauge the impact.

Perhaps it is just the intent and the market was surprised that this is having a large impact.

What is more interesting to me is that the move was seen as needed given JPY benchmark markets were viewed as “dysfunctional”.

The UK experience of dysfunctional government markets was something to behold.

It does not look/sound like the BoJ or markets are overly concerned and this dysfunction has been endemic for some time. So no panic, but I truly believe Central Bank’s tinkering adds complexity, which adds risk. Let markets set the price.

Overall rates look to be moving higher globally on the surprise and equities lower.

JPY govt bond yields jump:

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Credit

High Yield

The Itraxx Xover index closed +6bps yesterday having opened tighter dipping below 500. This morning it is opening a further 7.5bps wider at 520 bps.

Cash continues to lag the move wider and I think this will be the case until investors are back in January.

Similarly, we probably need a good few weeks >500bps in Xover before it becomes a proper resistance level for markets.

Again Jan is when I think this upward pressure could emerge.

We will not be out of the Eco-watching, Central Bank front-running/guessing meme that we have endured for the last 6 months any time soon.

Until we see a weakness in earnings those looking for signs of a pivot or a pause may drive markets higher.

Jan is when we will know if the bear market rally is dead.

GBP, EUR and USD spread moves were -1 bps (691 bps), +4 bps (509 bps) and +1 bps (476 bps) respectively.

Investment Grade

Total returns reflected the rates move (see below) with GBP IG the underperformer on a total return basis, followed by the US.

IG credit in Europe and the UK underperformed Equities and High-Yield on the day whilst in the US performance was comparable to that of the equity indices.

Overall upward pressure on yields is likely to continue this morning.

GBP, EUR and USD spread moves were +2 bps (195 bps), +0 bps (173 bps) and +1 bps (134 bps) respectively.

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Rates

Gilts had a rough day in light trading, a whopping 17bps higher across the curve.

The main driver was the expected additional supply as the BoE unwinds supply. This is something we flagged in CMD #53 high lighting the FT’s article on the coming deluge.

Interestingly 10-year yields hit the 3.5% target for 2023 as reported by the BoE’s Market Participant’s survey.

Bloomberg reports that Goldman Sachs has 4% pencilled in for the 10-year yield in Q1 ’23 so it looks like the overall path to lower Gilt yields in 2023 is not going to be straightforward.

Supply and remaining hikes will have potentially a significant impact near term.

Away from Gilts Bunds and Treasuries also moved wider across the curve both bear steepening.

This morning post the BoJ’s announcement yields continue to drift higher.

The 10-year Gilt, Bund and Treasury yield 350bps, 225bps and 365bps respectively.

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Equities

Equities followed a pattern we have seen throughout the year with European and UK equities recovering prior session’s losses only for US equities to close lower, albeit this time they opened in the red.

Given the “hawkish” news out of the BoJ and thin liquidity Futures in Europe and the UK look to be down between -60 and -90bps.

US futures are down between -44bps and -80bps.

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Today’s Events

Eco Data

Housing data in the US will dominate we have housing starts and building permits. We also have Eurozone consumer confidence.

Today’s Reporting

Douglas

What Has Caught Our Eye

China: Covid

There has been a noticeable increase in the amount of newsflow and anec-data pointing to Covid’s rapid rise in China.

People are calling for a death toll of 1mm+ and point to China’s limited capacity to deal with such a surge.

Further, we are now seeing speculation around new variants being born from the virus’ sweep through the world’s most populous country.

Hard facts are likely to remain hard to come by in the near term given the Chinese state’s control of the narrative.

That does not mean the issue cannot weigh on risk assets or as we have highlighted before mar the “China is reopening” story.

All of this is a long way of saying we may have to deal with Covid 1 last (I hope) time over the next few months and it is something to keep an eye on.

The thread from Eric Feigl-Ding is not for the faint hearted. Subsequent tweets show bodies on gurneys.

China: Central Economic Work Conference

China has just held its Central Economic Work Forum which is a top-level party conference that focuses on China’s economic outlook.

Given Zero-Covid’s demise and the impact that the disease will have in the coming weeks this meeting is significant as it sets out the leader’s current thinking.

The biggest announcement is that Chinese Authorities are looking to pivot away from dependence on the Chinese property market and deflate the bubble in property markets further.

4/4
All of this suggests that to become anywhere close to a "normal" economy (and after 3-4 decades of breakneck expansion, even that is probably too much) requires a lot more contraction in the property sector than we've yet seen.

— Michael Pettis (@michaelxpettis) December 20, 2022

Performance

High Yield

Investment Grade

Rates

Equities