Snapshot  |  September 14, 2022

Corporate Credit Snapshot – September 2022

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  • August was a month of two halves for global markets, with a very strong first half for credit followed by a weak second half
  • In the US, simultaneous concerns about inflation and recession (which could be triggered by a hawkish Federal Reserve response) resulted in another risk-off month with few places to hide
  • In Europe, positive early month momentum boosted by US economic data points faded on the back of rising concerns around the potential for a 75-basis point hike from the European Central Bank  
  • While Emerging Markets (EM) were not immune to a broad global rise in rates, EM outperformed in August. EM outperformance was driven this month by China’s aggressive loosening of monetary policy, fiscal policy, and monetary regulation

US:
Even though the first part of August saw a continuation of July’s risk asset rally, the summer ended for the US markets much as it began.  Simultaneous concerns about inflation and recession (which could be triggered by continued Fed hawkishness) resulted in another risk-off month with few places to hide.  The yield-to-worst of 10-year Treasuries ended the month over 3% and US high yield (HY) moved back over 8% (Source: Bloomberg).  HY spreads widened considerably, led by CCC rated assets, before some tightening again at month-end.  Much of the economic data for the month, particularly around consumer sentiment, suggested that the economy was not slowing fast enough to cause the Federal Reserve (Fed) to halt or pivot from its tightening path.  Fed Chair Powell reinforced this view with comments at the Jackson Hole meeting.  It’s worth noting that August (particularly the weeks before the US Labor Day holiday which fell this year on 5 September), is typically one of the least liquid periods of the year.  The market pullback and volatility during this time was not terribly surprising, especially given credit’s massive rally from the start of July to mid-August.

Europe:
It was a month of two halves for European credit, with positive early month momentum boosted by US economic data points fading on the back of rising concerns around on the potential for a 75-basis point hike from the European Central Bank (ECB).  Ongoing hawkishness from US Federal Reserve (Fed) Chair Powell, reflected in his annual Jackson Hole speech, also contributed to dampened sentiment. As a result, European credit markets ended the month with a reversal of gains as rates moved higher and spreads widened. However, there was a notable dispersion in performance between high yield (HY) and investment grade (IG) with yields in the latter rising considerably higher on the back of additional rates pressures, creating volatility. Ongoing high inflation data, elevated gas prices, and hawkish comments from key ECB speakers led by Isabel Schnabel kept the upward pressure on European rates throughout the month. With many investors on summer leave contributing to a lack of buying, spreads moved notably wider.

EM:
While Emerging Markets (EM) were not immune to a broad global rise in rates, the hawkish rhetoric of central banks, and the inflation and recession concerns that affected markets globally, EM outperformed in August.  EM high yield (HY) risk assets managed to generate positive returns; the only risk asset class to achieve positive returns in a month that left little place to hide. EM outperformance was driven this month by China’s aggressive loosening of monetary policy, fiscal policy, and monetary regulation.  However, the challenges that China faces continue to be driven by its zero-COVID policy.  At the close of the month, both Chengdu and Shenzhen implemented partial lockdowns.   The negative effect of the lockdowns became evident with PMI data showing that activity contracted in August. The region also faces continued fallout from the homebuilder/real estate sector. Nevertheless, China’s Premier Li says stimulus is now ‘More Forceful’ than it was in 2020, and we agree. We expect further loosening of policy before the China Communist Party opens its 20th Party Congress on 16 Oct in Beijing.

Outlook:
Valuations have improved significantly over the last few months because rate hikes by developed market central banks have been priced into forward curves as have growing concerns about the European and Chinese economic cycles over the next couple of quarters.  As a result, we are seeing a divide between the US and non-US outlooks. While China is facing many difficulties, including the consequences of the zero-COVID policy, its government has engaged in a series of forceful measures to boost the fiscal and monetary stimuli from which we would expect to see results early next year. We remain somewhat worried about the ongoing overhang on Europe from the war and the associated, looming energy crisis.  In the US, we believe we have not seen the full cumulative effect from the Fed’s tightening activities and have not yet seen the impact from Quantitative Tightening (QT) measures.  We anticipate further slowing both of the economy and earnings.  However, the worst is not certain, and some lessening of recent strong inflationary pressures may help preserve chances for a soft landing if the Fed will slow down its rates tightening after the September meeting.  With current market spreads in the US implying defaults in excess of historical averages, we believe overall valuations have become fair again, even if a significant pickup in issuance activity in the US IG market may cause some technical pressure on spreads in the shorter term.  Similarly, European credit market valuations are significantly improved.  It remains to be seen how effective fiscal measures and changes to the energy market will be in helping households and industry contain energy bills and thereby dent headline inflation.

Nevertheless, we believe the value proposition of European HY already appears more attractive for long term investors.  Within EM, after factoring out China and Eastern Europe’s very wide spreads, we see overall valuations and reasonably solid fundamentals more aligned with those of developed markets.