Church House CEO Jeremy Wharton gives his usual in-depth summary of credit markets across the globe.
Markets remain in thrall of Central Bank action and volatility in bond markets has jumped. Bankers are dropping hints that interest rates may be ‘higher for longer’, some not so subtly, and, as the cost of borrowing returns to long-term normality, many people are still getting used to interest rates that they have not experienced before.
However, as the transmission system for higher Base Rates to the economy is seemingly more extended and inefficient now, the delay factor does run the risk of over tightening, something that Central Bankers seem to be willing to accept. Longer-dated Gilts and other fixed interest securities have been struggling again.
In the US, the absurd wranglings over their debt ceiling were resolved in time so we now have two years before they resurface. It remains an uncomfortable prospect that the US Government could have begun to default on its obligations. The rating agency Fitch thinks so and has put their AAA rating on ‘credit watch downgrade’.
The US Federal Reserve is rightly taking a brief pause in their hiking cycle, attempting to measure the effects of their ten straight hikes in their base rate. Stresses and strains were to be expected and Fed Chairman Powell has warned of them many times. We saw the regional banking problems in the first quarter, but strains are also visible in the commercial real estate and Collateralised Loan markets where values have plummeted, and credit spreads have ballooned.
The European Central Bank (ECB) remains on course to pile on the pain, remember that it is still less than a year ago that they were (crazily) pursuing a negative interest rate policy. Germany’s technical recession is evidence of that pain, but their recent manufacturing numbers were stronger and some cause for optimism that this recession may be short and shallow.
Eurozone core inflation numbers for June were not encouraging though as they showed a re-acceleration to 5.4% as the cost of services increased. On a brighter note, recent ECB stress tests of European banks saw them all ‘sail through’. Fitch downgraded France to AA rating - and it is intriguing how the former PIIGS (Portugal, Italy, Ireland, Greece and Spain) have picked up the baton for EU growth, the recovery in the likes of the Greek economy is astonishing.
The Bank of England and its Governor are fighting for their credibility in a way that we have not experienced before. Whilst no one envies them their role, the delay in withdrawing liquidity and starting to normalise interest rates was down to their procrastination and no one else’s.
The effects of their last hike to 5% are still reverberating around mortgage markets and yet we still have not seen a moderation in core inflation rates. The market quickly repriced (fell!) after the first rather alarming thirty-year high print in core inflation and money market rates now price in hikes to 6.5% for the Base Rate in December. Recent advocates of buying duration (longer-term assets) were again reminded of their volatility, the thirty-year Gilt is down around 15% over the year to date.
The pattern of issuance of new corporate bonds (in sterling) continues to be skewed to short and medium-term issues, and with two-year Gilts now yielding well over 5% there are some remarkable rates being paid by high grade borrowers. Credit spreads have remained stable, trading in a tight range since recovering from the March banking inspired volatility.
Primary market issuers have continued to offer favourable spreads across all currencies. We saw a $31bn whopper from Pfizer which attracted interest of over $85bn but also some good quality sterling bonds. As issuers cast around for different rate and risk profiles, we have the spectre of Credit Agricole issuing an inaugural ‘Panda bond’ denominated in Yuan into Chinese markets. The proceeds are to be remitted offshore for use in their ongoing operations, but it feels like this has a whole new arena of risk attached to it.
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