June rounded off a brutal first half for risk assets, with 2022 turning into everything that 2021 wasn’t.
Credit spreads traded in a tight range all last year, in contrast we close out at the widest levels seen since March 2020 before central bank action stabilised markets, the most volatile period seen for credit since the PIIGS blew up. Sovereign yields have reacted to a different kind of central bank action as QE winds down and rates are hiked in the face of the kind of inflation prints not seen for many decades.
The Federal Reserve is now leading the charge and at the next FOMC meeting we are likely to see another 75bp hike with plenty more to come judging by the overt hawkish language of most voting members. Put this in the context of the fact they only started hiking in March and no wonder that risk assets have taken fright. The 10-year US Treasury yields reached just shy of 3.5% in mid-June and for many this was the forecast terminal rate, the peak in this hiking cycle. As fears of these actions and the continued removal of monetary stimulus provoked worries of a sharp slowdown, or even a mild recession, yields fell back again to 2.80%.
In contrast the ECB was still talking and not doing, although their language was also becoming more aggressive. They have just delivered a 50bp hike, but they continue to have a much finer line to tread, not only because of the usual historical disparity in the size and durability of their member economies, but also because the Ukraine conflict has laid starkly bare the reliance on external sources of energy. We are not yet in the territory of the above mentioned sovereign debt crisis of 2011 but sovereign spreads have gapped wider. The ECB has responded with the intention to implement a new acronym, TPI, a Transmission Protection Instrument i.e. a spread cap (control) facility. The EUR continues to hover around parity with the USD.
The Bank of England continues on its rather less aggressive rate hiking path as they agonise over cost of living pressures and they now have a full blown political crisis to think about. Thankfully, so far, this is seen as a sideshow to how the actual UK economy is performing, but Sterling gives us plenty of pointers as it weakens further.
Underlying credit market activity however does remain relatively healthy. Primary market issuance levels are markedly down, especially in High Yield, but some Investment Grade issuers are managing to print albeit only at levels that correctly compensate investors. For the moment the days of little or no new issue premium are over.
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