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Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: A liquidity driven melt-up remains the key driver of bank credit spread performance. As US banks push deposits into money market funds, to manage their Supplemental Leverage Ratio requirements, the short end of the rates market continues to push investors up the curve to generate returns. Awash with still rising liquidity, this melt-up is the key driver of credit spread outperformance.Risk asset volatility and talking about, talking about, talking about tapering had little lasting impact on US interest rates over the last week. In fact, rate curve flattening, and forward breakeven rate declines, suggest that the interest rate market may buy the Fed’s assessment of inflation as being transitory. While the transitory mantra is believed, whispers of supply driven growth constraints are being mentioned. This would be interest rate and credit spread positive as it would extend the duration of the recovery and thereby delay late-stage economic cycle repositioning.The risk is clearly that the rates market is underpricing the potential for an extended period of higher than anticipated inflation. However, holding cash is expensive and moving too early to position for higher or longer than anticipated inflation may be career ending. Ergo, the silent self-doubtful suffering of the rate and credit markets.We elaborate on these themes within.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Executive Summary: A liquidity driven melt-up remains the key driver of bank credit spread performance. As US banks push deposits into money market funds, to manage their Supplemental Leverage Ratio requirements, the short end of the rates market continues to push investors up the curve to generate returns. Awash with still rising liquidity, this melt-up is the key driver of credit spread outperformance.Risk asset volatility and talking about, talking about, talking about tapering had little lasting impact on US interest rates over the last week. In fact, rate curve flattening, and forward breakeven rate declines, suggest that the interest rate market may buy the Fed’s assessment of inflation as being transitory. While the transitory mantra is believed, whispers of supply driven growth constraints are being mentioned. This would be interest rate and credit spread positive as it would extend the duration of the recovery and thereby delay late-stage economic cycle repositioning.The risk is clearly that the rates market is underpricing the potential for an extended period of higher than anticipated inflation. However, holding cash is expensive and moving too early to position for higher or longer than anticipated inflation may be career ending. Ergo, the silent self-doubtful suffering of the rate and credit markets.We elaborate on these themes within.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Bank Credit Weekly: Liquidity Driven Melt-Up Pulls Spreads Tighter

Asia High Yield Bond Index

Bank Credit Weekly: Liquidity Driven Melt-Up Pulls Spreads Tighter