Credit Market Daily #68 %author %

16-Jan-2023

We are back after a bout of ‘flu.

This note will take a look at the last week’s price action which was extremely positive. UK assets generally outperformed with the exception being US small caps.

Xover tightened significantly on the week and currently sits at 415 bps, down from 474 on the 30th of December. We are still sticking to our call for Xover to head back out to 500, into month end.

We have 2 weeks until the next round of Central Bank meetings and there is no such thing as a dovish hike.

Secondly financial conditions continue to loosen as assets perform strongly, something Central Banks are not looking to entertain right now.

Hence central banks may concede that inflation is moving lower, but are unlikely to change the refrain regarding the length at which rates will be kept high in 2023.

What Has Changed?

Markets liked the lower US CPI numbers (although we noted that the “now-cast” expectations suggested even lower prints).

This combined with lower energy prices all points to more flexibility for central banks, potentially shallower recessions with elevated, but lower, rates for longer.

Overall there has been a broad-based risk on move across all asset classes.

Interestingly, Earnings expectations have turned much lower (see what caught our eye below) so much so they now look to represent risks to the upside.

Earnings season is just starting and we do expect a deterioration in earnings over the next 2-3 quarters which should be associated with a widening in credit spreads.

Overall – EUR and USD credit based on their 12 month z scores remain moderately expensive, whilst GBP credit is clearly playing catch up and remains fairly valued.

Net-net I can’t help feeling that we have got ahead of ourselves, and near term there is a risk to the downside as investor confidence meets Central Bank rhetoric against a background of softer corporate earnings.

The big gotcha is if corporate earnings, given the amount of pessimism baked in, don’t soften until Q2.

Strong Moves 9th to 13th January

Asset Class	EUR	GBP	USD
High Yield	+141 bps	+182 bps	+157 bps
Investment Grade	+76 bps	+198 bps	+140 bps
Equity*	+185 bps	+230 bps	+527 bps
Rates**	+32 bps	+89 bps	+59 bps

* Euro Stoxx 600, FTSE 250 and Russell 2000 Equity indices, ** 10-Year Bund and Gilt, S&P 10-Year UST Total Return Index

Credit

High Yield

Overall High Yield credit had a strong week.

RV wise we are around fair value in GBP HY and fair to expensive in EUR and USD high yield.

This is in the context of the previous 12 months.

Overall levels of carry remain attractive, with break even’s (spread/duration) offering more value than outright spreads based on their Z scores.

Relative value is going to become increasingly important as the year progresses and “safe carry” is snapped up by the record cash that has been waiting on the sidelines and that appears to be being put to use.

Recent positive performance has also seen the European High Yield market open. “Buying brings out buyers”.

BB-/BB rated Sugar producer Tereos is out with a 5NC2 Senior unsecured bond this morning.

The Q1 ’23 European High Yield Online x Bloomberg intelligence High Yield Investor survey is open for institutional investors and should shed a light on how sentiment and valuations have changed since our Q4 survey. If you can take part – please do so here.

In terms of spread movements on the week GBP, EUR and USD High Yield indices moved -22bps (Z+649 bps), -20bps (Z+456 bps) and -16bps (Z+431 bps) respectively.

Leaders and Laggers

Investment Grade

It was a similar story in investment grade as with high yield.

Strong credit performance aided by the supportive move in rates resulting in a positive return for the week.

In terms of relative value there is less of a gap when comparing GBP, EUR and USD by zscore with GBP at fair value and EUR and USD spreads approaching fair/expensive.

In investment grade there has been a deluge of new issuance, the flood gates well and truly open.

Last week the Euro MTN market saw c. €13.75 bn of issuance across 57 bonds.

Financials were the bulk of issuance (I plan on preparing a summary by sector) and overall investors were more than happy to buy, with books well subscribed.

In terms of spread movements on the week GBP, EUR and USD High Yield indices moved -12bps (Z+172 bps), -7bps (Z+168 bps) and -7bps (Z+125 bps) respectively.

What Has Caught Our Eye

WEF: Global Risk Report

The Visual Capitalist has summarised the WEF Global Risk report’s top risks for the year. The report can be downloaded here.

Even if the economic fallout remains comparatively contained, global growth is forecast to slow to 2.7% in 2023, with around one-third of the world’s economy facing a technical recession – the third weakest growth profile in over 20 years.18 This downturn will be led by advanced markets, with projected growth falling to 1.1% in 2023
WEF Global Risk Report 2023

Callum Thomas’ Chart Storm

If you do not subscribe to Callum Thomas’ substack then you should, these charts are from his S&P 500 chart storm.

What struck me is that net sentiment and earnings expectations are significantly more negative than in Q4 and yet valuations are at risk of breaking out.

There are a number of fin twitters expecting a further rally in equities followed by a significant draw-down.

What is clear is that there is the valuation gap remains with equities/ expectations/ sentiment remaining out of sync.