Snapshot  |  November 15, 2022

Corporate Credit Snapshot – November 2022

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  • Global markets delivered mixed returns this month as risk assets rallied in anticipation of a more dovish monetary policy “pivot” from major central banks
  • In the US, lower than expected PMIs, housing data (both price and activity), and durable goods orders, gave investors some hope that the Fed’s rate policy is having an impact on demand trends
  • In Europe, risk assets broadly delivered positive returns in October on the back of the UK crisis resolution and a more dovish tone (if somewhat muddled messaging) from the European Central Bank (ECB)
  • While emerging markets (EM) did benefit from the central bank “pivot” drumbeat, China saw no “pivot” politically.  As such, no immediate changes are expected for China’s zero-COVID policy, nor any changes in course for its political intensions

US
Fixed income delivered mixed returns in October with high yield (HY) delivering positive returns even as higher interest rates led to negative returns for investment grade (IG) corporates and Treasuries.  Market sentiment benefitted from growing expectations that the Federal Reserve (Fed) will reassess the impact of actual and expected hikes on the US economy, supporting a slower pace of hikes after the November meeting.  On top of this, lower than expected PMIs, housing data (both price and activity), and durable goods orders, gave investors some hope that the Fed’s rate policy is having an impact on demand trends.  These factors contributed to a less hawkish outlook for the Fed, although market pricing for the Fed terminal rate did rebound back close to 5% by end of the month.  Investors now speculate that November may be the last of the 75 bps rate moves as the economy is slowing after prior increases.  That said, US consumer income and spending numbers remained on track in our view, indicating that the employment situation is enabling consumers to maintain their healthy balance sheets and spending activity.  Corporate earnings reporting continued to demonstrate resiliency of sales, cash flows, and earnings. 

EUROPE
Risk assets rallied this month, delivering broadly positive returns in October on the back of the UK crisis resolution, a more dovish tone from the European Central Bank (ECB), and a less hawkish outlook for the Federal Reserve (Fed).  On the UK side, Liz Truss resigned as Prime Minister and the government effectively abandoned the proposed unfunded tax cuts that previously roiled UK and global bond markets. Rishi Sunak, largely regarded as the most market-friendly candidate, was named as the new Prime Minister. As a result, the UK gilt market had largely normalized by late October, and the British pound reversed its related losses. Euro-area inflation surged higher with Spain as the only outlier, falling and printing below forecasts, while PMIs continued to indicate contraction in the Euro-area. Although recession has long been expected, these fears have become more fully realized.  One bright spot was gas prices, which continue to drift lower, helped by the unseasonably warm temperatures across Europe and the UK.  As of 27th October 2022, the ECB increased its Main Refinancing Operation Rate (MRO) by 75bps to 2%, in-line with expectations and removed the favourable targeted longer-term refinancing operations (TLTRO) funding terms for banks (which is expected to lead to early repayment by banks and thus a significant shrinking of the ECB’s balance sheet).  However, the press conference brought mixed messages with ECB President Christine Lagarde focusing both on the considerable hikes already delivered and the need to do more over coming meetings.

EM
October continued to be a challenging month for Emerging Markets (EM) even as risk assets rallied in anticipation of a more dovish monetary policy “pivot” from major central banks globally.  Market sentiment benefitted from growing expectations that the Federal Reserve (Fed) will slow the pace of hikes after the November meeting, and the European Central Bank (ECB) struck a more dovish tone at its recent conference.  As of 26th October 2022, the Brazilian central bank paused, keeping its Selic rate at 13.75%.  On the same day, the central Bank of Canada surprised by hiking base rates below expectations, increasing 50 basis points (bps) instead of the expected 75bps, before communicating growth outlook concerns. As the world has been dealing with a supply side shock (i.e., not enough fuel, labor, or goods), weaker activity data has been welcome news as we believe it should (with a lag) lead to lower inflation and encourage central banks to think twice about further extending their aggressive hiking cycles. China was the one exception, where we saw no “pivot” politically. At the closing of the 20th Communist Party Congress, the world was introduced to the new Politburo standing committee that will run China for the next 5 years.  It was filled with loyalists to President Xi without a clear successor in sight.  As such, no immediate changes are expected for China’s zero-COVID policy, nor any changes in course for its political intensions.

OUTLOOK
Earnings releases will continue heading into the new month.  A continuation of the trend of the early reporters will provide a tailwind for high yield, but we will need to see if the late reporters (often smaller companies), can continue the momentum.  At month-end investors are waiting with bated breath for the upcoming November Fed meeting.  We believe any indication that the Fed could start to reduce the pace of hikes could be helpful for the market, while a hawkish tone, possibly to stem the recent rally in risk assets, would be unfavorable.  We expect significant market volatility in either scenario.  In our view, current spreads indicate that globally corporate credit is relatively fairly valued based on the current economic environment. We expect continued volatility over the coming months due the Russia-Ukraine war, the European energy situation going into winter, China’s zero-COVID policy, and a slowing US economy.  We expect climate change to remain a topic that will increasingly move to the forefront of risk analysis and decision making.  We maintain that the strong rally in risk assets this month is just another example of how difficult it is to time markets.  The market often looks much farther ahead than most investors and moves accordingly.  In the long run, while it is difficult for traders to consistently anticipate news and how it impacts markets, we believe long-term investors with diversified asset allocations can weather storms.  While we are cautious given the clouds on the horizon, we continue to believe that yields are at compelling values for high yield relative to other fixed income assets in a low default environment.