The October volatility has so far proved to be an inflection point for risk assets. Central Banks have gone a long way down the road to normalise rates and while there is further to go markets have discounted a lot of future moves.
They are also looking ahead to a potential global recession next year with all the effects that would have on valuations and future moves in rates. Reduction in Central Bank balance sheets, quantitative tightening, in contrast has hardly started.
The Federal Reserve remains wary that markets might be misinterpreting their willingness to keep tightening. They appear determined to keep hiking until inflation is firmly under control and while there is debate in the FOMC about the exact timing and size of hikes there appears to be unity that the peak in rates is likely to be higher than their quarterly projections in September indicated. Chairman Powell reiterated this after the November meeting at which they moved another 75 bp putting the target rate close to the 10 year yield. Since then growth worries have pushed down longer dated yields and the US curve is now inverted.
Recent Eurozone PMI’s make grim reading as energy costs and recession fears continue to weigh heavily on sentiment. They were however marginally better than consensus meaning that there remains hope that a recessionary period is shorter and shallower than some are expecting. The ECB delivered their own 75bp hike although the size of their next hike is uncertain, this all in the context of 2yr German government paper starting the year at -.075%, now at 2.2%.
A new Prime Minister and Chancellor helped Gilt yields to continue their rally away from the worst levels delivered by their predecessors. Another budget, in conjunction with OBR this time, has restored some credibility to UK plc and UK sovereign CDS have halved from their wides of 52, which was just shy of the pandemic panic peak. The Bank delivered their 75bp hike as CPI printed at 11.1%. The outlook for UK economic activity also looks pretty grim although again UK PMI’s surprised to the upside.
Credit spreads continue to rally from their wides but still offer plenty of value and all-in yields remain very compelling, corporate credit now has one of the more predictable return profiles of most asset classes. The primary market came back to life and we are seeing several high quality names issuing into willing hands but still needing to offer fair premiums and there are some coupons printing that we haven’t seen for many years. Interestingly the trend of issuance has been markedly into shorter tenors with issuers trying to look through the rate cycle. The Gilt curve is pretty much flat so there is little compensation for investors going further out anyway.
The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article.
Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.