Credit Market Daily #67 %author %

06-January-2023

Good Morning!

So, what has happened since Wednesday – the overall price action has been relatively positive in Credit.

Equities’ ebullient tone in Europe driven by lower-than-expected national CPI numbers contrasted with the US.

The US ADP jobs numbers coming in stronger than expected and FED speakers net pointing to further tightening.

Equities in Europe opened up flat to small-up and have stayed there. We have had Eurozone CPI come in at 9.2% YoY vs. 9.5% expected and 10.1% previously.

This was largely expected given the downward surprises seen in the FR, IT and DE country numbers this week.

As mentioned previously the decline is expected to be temporary, driven by German energy price caps coming into effect, with a pick-up expected in later readings as higher prices feed through to retail.

Eurozone core CPI (excl. Energy, Foo, Alcohol and Tobacco) actually came in slightly higher than consensus, 5.2% YoY vs. 5.1% expected and 5% previous, reaching new highs.

The data will keep the ECB on the offensive w.r.t. rates.

Core CPI -Up, Total CPI continues to roll over.

European CPI though is the Amuse Bouche before the main event – we have the NFP and Household employment survey.

These will likely drive risk asset direction for the coming days given the importance the FED has put on weakening a very tight employment market.

In the UK the Construction PMI turned lower for December coming in at 48 v.s. 52 expected and 50.4 previously. Construction remains another of the canaries likely to sing loudly in ’23 with housing a leading indicator of things to come.

I have read through the JP Morgan and CS European credit strategy outlooks and have summarised/ highlighted some charts below.

The JP piece is from November, CS’s is in December. Both think that Investment Grade Credit will outperform High Yield, driven by better fundamentals and valuations.

Interestingly though JP sees European Investment Grade tightening in spread terms, whilst expecting High Yield Spreads to widen. CS on the other hand has both Investment Grade and High Yield spreads wider on the year.

One of the pillars of JP’s theorising is the impact of Energy prices and that moderation in pricing and adequate supply will likely mean any recession in Europe is relatively shallow.

This is indeed what has come to pass since November and I have included a piece in “What We are Watching” below that highlights the current level of Europe’s gas storage.

The fundamental impact of falling gas prices could prove significant for high-yield issuers. For instance, Iceland Ltd said that it was not fully hedged for ’23 and thought Gas prices would normalise.

The question will be, did they lock in prices at recent highs in Q4 or did they hold out and will benefit from the recent decline?

We shall see as reporting season starts.

Talking of reporting, Next and B&M both reported strong trading updates and guidance upgrades. This has to be positive in that retailers appear to be able to grow revenue in Q4.

Next sees its cost inflation improving but remaining high:

“We now expect the cost price inflation on like-for-like goods to peak at around 8% in the Spring Summer season. However, we expect inflation to be no more than 6% in the second half. This Autumn Winter figure is only an estimate at this stage, as we are still negotiating prices; but it does appear that cost pressures are now easing through a combination of reducing freight costs and lower factory gate (dollar) prices… Much of the increase in next year’s prices are the result of the devaluation of the pound against the dollar. Eighty percent of our contracts are negotiated in dollars so the devaluation of the pound has had a significant impact on our prices.”
Next Trading Statement

Next’s profit bridge for the year gives a good idea of where retailers are feeling the pain, along with the guidance on the timing of cost improvements it provides a decent bell weather for the sector.

Credit

High Yield

Credit has been relatively stable over the last few days and Xover is currently hovering around 446, 2 tighter on the day and 6 bps wider than Wednesday.

In terms of cash indices GBP, EUR and USD index spreads moved -6bps (Z+687), -1bp (Z+493) and -8bps (Z+477) respectively.

Leaders and Laggers

Investment Grade

IG had a mixed day yesterday with total returns being impacted by the weakness in Government bonds post the US jobs data.

GBP, EUR and USD index spreads moved -2bps (Z+193), +2bp (Z+172) and +2bps (Z+133) respectively.

Itraxx Main is currently trading at 85, -1bp on the day and +1bp relative to Wednesday.

Rates

Benchmarks ended the day wider yesterday with yields increasing on the back of the ADP Jobs data.

This morning’s open was soft with bonds 1-3bps wider in yield. Currently, benchmarks are -1 to -3bps tighter.

The 10-year Gilt, Bund and Treasury yield 355bps, 228bps and 372bps respectively.

As mentioned above NFPs/Household Jobs numbers in the US are likely to set the tone this afternoon.

Equities

Equity indices opened up between 10 to 25bps in Europe. US futures are pointing to similar moves.

What Has Caught Our Eye

JP Morgan Credit Outlook & Strategy 2023: “Safe Carry”

Important to note this was published on November 16th 2022.

For reference, Itraxx Main was +96bps vs. 85bps today and Xover was 477 vs. 447 today something to be mindful of.

Overall they are positive on Investment Grade both in Europe and the UK, with the latter expected to underperform its European peers – this is mainly driven by the higher duration of GBP credit as well as the tougher economic outlook.

The Outlook can be downloaded here

Here are their year-end targets for the asset classes

“In our view, we are already past the worst for euro credit spreads and returns this cycle, although the road from here could still be bumpy and uneven over the next year. Only a few months ago, the popular narrative was that surging energy prices and disruption to natural gas supplies would cause a deep recession in Europe over the upcoming winter, while in the US the Fed would be forced to engineer a ‘hard landing’ to tame runaway inflation. To make things worse, it looked like China’s economy would continue to be held back by a strict Zero-Covid policy and a snowballing crisis in the real estate market”
JPM Credit Outlook and Strategy 16th November

Generally, JPM’s outlook calls for increased dispersion across asset classes due to fundamentals, remaining defensive in positioning with value in investment grade. High Yield is viewed as less compelling with spread widening on the back of softer fundamentals and increasing default rates.

JPM’s European Credit Strategy Picks for ’23:

Credit Suisse Credit Outlook 2023

Similarly, CS prefer European Investment Grade over High Yield – again driven by both fundamentals and relative value.

Their outlook was published on the 14th of December it can be downloaded here

They expect spreads to widen across all asset classes, and like JPM point to supportive technicals for 2023 in terms of lower primary issuance.

John Kemp: “Europe’s gas prices slump to moderate storage build”

From famine to Feast…

This article from Reuters and if you subscribe to John’s newsletter his European Gas Inventories Chart Book gives a salient update on current Gas inventories in Europe and the future trajectory of prices.

Essentially current inventories are looking like they will end winter around 50% full (!) this has clear demand implications for the rest of the year – pointing to lower prices, lower inflation and potentially higher corporate margins.

Stocks are now 218 TWh (+30% or +1.98 standard deviations) above the prior 10-year seasonal average up from a surplus of 92 TWh (+10% or +0.86 standard deviations) when the winter season started on October 1.
Inventories are on course to fall to around 562 TWh before the end of winter, with a likely range of 435 TWh to 743 TWh, based on seasonal movements over the past 10 years…
Total storage capacity is only 1,129 TWh so the system is on track to end winter 50% full (with a probable range of 39% to 66%). This would not leave much volume for additional gas to be added during the low-consumption refill season from April to September
John Kemp, 4-Jan-23

Credit Market Daily #67