New challenges for central bankers and shifting risks for investors in credit. Shaky corporates, strong consumers, sensitive CLOs and liquidity spillovers. Contributions from Barclays, DB, GS, MS and the NY Fed.
Markets: Shifty policy
Central bankers in Europe have their eye on Brexit, central bankers in Japan have their eye on a flagging economy and central bankers in the US have their eye on everything. The UK government said last week that it intended to trigger the first act of Brexit, Article 50, by March next year and take a hard line on the contentious issues of immigration, budget payments, lawmaking and freedom from EU judicial review. The intent to clearly separate drove down the British pound and pushed up 10-year yields on Sterling. The ECB, meanwhile, signaled that it may slow QE as Brexit starts. That maintains loose EU policy but at a slower pace. The ECB may be running out of viable QE assets. Prospects for growth and inflation in the EU remain weak. In Japan, weak inflation data and weak results in the Tankan business survey set the BoJ up for easing at its upcoming Oct 30-Nov 1 meeting. Together with the slightly weak September payrolls, the market now prices the prospects of a December Fed hike around 50%. See Barclays Global Economics Weekly, 7 Oct 2016. (Barclays, Milepost).
Markets: Labored easing
Fed Chair Yellen sited rising workforce participation after the September FOMC as one reason to delay a hike, arguing that a strong labor market had started pulling people back into the workforce. Although September payrolls fell short of consensus at 156K, they also came with an uptick in labor market participation to 62.9%. Score one for Yellen, but Barclays questions her logic. The current participation rate is only 0.1% higher than October 2013, Barclays points out, and seems almost entirely due to a surge in participation from women aged 25-34. The long-term unemployed also seem more willing to keep looking for a job but no more likely to find one. The rush of young women and the persistence of the unemployed are far from a stampede into the workforce. The labor market is tightening. See Barclays Global Economics Weekly, 7 Oct 2016. (Barclays, Milepost).
Markets: Rich credit, poor credit
The travails of the most vulnerable corporate issuers keep flashing warning signs about credit. Among high yield issuers outside the commodity sector, 37% trade at 10% yields or higher, according to Deutsche Bank, a level consistent with default rates at least 2.5 times higher than the market has priced in. About 42% of these issuers haven’t issued debt in at least three years, a level last seen before the recessions of 2001 and 2008. And 43% of these issuers have 2-year debt trading at least 300 bp wider than 6-year debt, another traditional sign of credit stress. The flow of foreign money into US credit has helped richen the sector. Deutsche Bank continues to argue that a reach for yield has blinded the market to the warning signs. See Deutsche’s US Credit Strategy, 8 Oct 2016. (DB, Milepost).
Markets: Structured credit
While fundamentals in corporate credit have left analysts nervous, consumer credit seems strong. “Household debt service ratios are now at at a 35-year low,” Goldman Sachs writes, “and credit card and mortgage delinquency rates continue to decline.” Spreads in ABS and residential credit have tightened this year, although not as much as corporate debt. That leaves structured consumer credit looking like the better relative value. See Goldman Sachs, The Mortgage Trader, 7 Oct 2016. (GS, Milepost).
Markets: Sensitive CLOs
By design, not all classes of collateralized loan obligations are equal. They show very different price sensitivities to the underlying leveraged loans, according to Morgan Stanley. The average AAA class from 2014 to today has moved $0.20 for every $1 change in the price of loans while the average equity class has moved $3.32. Other rated classes fall in between. That should give investors an idea about the relative amount of leverage embedded in a slice of CLO. See Morgan Stanley’s CLO Relative Value Debate Series 2: D for Delta, 04 Oct 2016.
Markets: Corporate illiquidity spillover
It’s no surprise that portfolios under stress often sell what they can rather than what they should. That apparently was the case from 2014 through 2015 as portfolios of corporate debt wrestled with a collapse in oil. Profits at energy companies fell and, as the companies borrowed to fund operations, leverage rose. Instead of selling energy positions, managers of corporate bond portfolios sold other holdings that still had liquidity. That’s the finding of the NY Fed in a posting last week. For non-energy corporate bonds, oil prices became a big predictor of spreads and so did redemptions from corporate bond funds. See the Liberty Street Economics post here.