Musings on Markets (Dated 19/06/2022)

14th June – 19th June

Inflation & rates continue to occupy markets.

The pandemic response saw a historically loose period of monetary policy. This fuelled a sharp rise in the prices of risk assets; and created conditions where the impact of supply side shocks (Ukraine, post COVID reopening) have had an exacerbated impact on price levels.

With CPI running at 7-8% across the EU / US vs 2% targets, central banks are being forced to reverse loose monetary policy to tame inflation – sending risk assets in the opposite direction from their meteoric rise post March 2020. 

As such, this week (at the time of writing, Friday lunchtime) has seen declines of 2.2% in the SPX (down -22% YTD). This was driven by the FED raising interest rates by 75bps (the largest since 1994). 

Wednesday’s rate rise was accompanied by hawkish comments noting the possibility of another 75bp hike at the July meeting and the Fed’s “acute focus” on returning inflation to its 2% target.

“Fragmentation” has been the word of the week in Europe. Italian bonds saw yields surge last week as bonds sold off after the ECB signaled a scaling back of its large scale bond purchases programme & rate rises next month to tame inflation. 

Highly leveraged economies (namely Italy, Greece) are particularly susceptible to financial distress due to interest rate rises. 

To counteract the “fragmentation” in European government bond yields (i.e. the difference in yields between German bunds & Italian govt bonds increasing) the ECB called an extraordinary meeting to announce its “anti-fragmentation instrument”. This will essentially see the ECB invest in Italian government bonds preferentially over their German counterparts to manage Italian yields. 

We also had a surprise from the Swiss central bank, which raised rates by 50bps. Switzerland has historically been reluctant to raise interest rates (having not raised rates since 2007), the Suisse central bank rate now stands at -0.25%.

In the UK, the BOE has remained steady with it’s series of 0.25% rate rises, increasing the base rate to 1.25% on Thursday. The BOE is juggling a slowing UK economy with the need to tackle high inflation (now expected to hit 11% this October). 

Tesco released an interesting trading statement on Friday noting that customers were facing “unprecedented increases in the cost of living”, with sales dropping by 1.5% for the three months to the 28th of May.

In terms of Credit GBP, HY Corporates returned c.-254 basis points (bps) on the week, with Financials under-performing Non-Financials each returning c.-256 bps, and -253bps respectively. In terms of rating, Double BBs returned -240bps, whilst Single Bs and CCCs returned –278bps and -267bps respectively.

At time of writing (Fri 27th, Afternoon) The FTSE is down c2.6% on the week. GBP / USD is up 0.66% on the week at c.1.221. The spread on the iTraxx Crossover (XOVER) – a proxy for the market’s assessment of credit risk (the greater the spread, the greater the perceived risk) increased by c.45bps over the week to 563.