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Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

With the ink on the Covid-19 stimulus bill yet to dry, the market has moved onto the next topic, infrastructure spending. This has further interest rate and credit spread implications.If you think one size fits all in credit, then you are sadly mistaken. We recently heard a respected cross-asset analyst state that credit is an interest rate product. WRONG! Credit is a spread product and interest rates can be hedged away, albeit at a cost. However, if you unhedged or are in the total return game, then capital preservation is the name of the game now. High grade credit is now mostly a duration instrument. Given that spreads are so low in high grade, there isn’t enough cushion to absorb a rise in rates. This sector of the credit matrix is essentially a shadow interest rate product and that is not what you want to be exposed to at this point in the business cycle. It is better to be in risk assets that are mainly driven by earnings, the economic outlook or those that reset with rates as opposed to those hindered by the interest rate outlook.That said, you can protect your downside moving to shorter duration, higher spreads, or a combination of the two in floating rate product, such as leveraged loans. Concurrently, while the ECB is essentially funding European banks at lower than market rates, the supply of short-dated floating rate bank debt is likely lower than usual. The ECB’s positioning should create a premium for this paper as the year progresses.Market Outlook: We see risk-on in high yield financials and more subordinated credit product as a play on economic recovery as well as a grab for shorter duration in higher rated financials as rising rates aggravate total return mandates. We do not expect the Fed to blink and ride to the rescue from rapidly rising rates, yet. Eventually it will capitulate to the market, but this may be some time off. Financial conditions remain extremely accommodative, and we have a long way back to reach full employment. Bouts of volatility should create buying opportunities.

With the ink on the Covid-19 stimulus bill yet to dry, the market has moved onto the next topic, infrastructure spending. This has further interest rate and credit spread implications.If you think one size fits all in credit, then you are sadly mistaken. We recently heard a respected cross-asset analyst state that credit is an interest rate product. WRONG! Credit is a spread product and interest rates can be hedged away, albeit at a cost. However, if you unhedged or are in the total return game, then capital preservation is the name of the game now. High grade credit is now mostly a duration instrument. Given that spreads are so low in high grade, there isn’t enough cushion to absorb a rise in rates. This sector of the credit matrix is essentially a shadow interest rate product and that is not what you want to be exposed to at this point in the business cycle. It is better to be in risk assets that are mainly driven by earnings, the economic outlook or those that reset with rates as opposed to those hindered by the interest rate outlook.That said, you can protect your downside moving to shorter duration, higher spreads, or a combination of the two in floating rate product, such as leveraged loans. Concurrently, while the ECB is essentially funding European banks at lower than market rates, the supply of short-dated floating rate bank debt is likely lower than usual. The ECB’s positioning should create a premium for this paper as the year progresses.Market Outlook: We see risk-on in high yield financials and more subordinated credit product as a play on economic recovery as well as a grab for shorter duration in higher rated financials as rising rates aggravate total return mandates. We do not expect the Fed to blink and ride to the rescue from rapidly rising rates, yet. Eventually it will capitulate to the market, but this may be some time off. Financial conditions remain extremely accommodative, and we have a long way back to reach full employment. Bouts of volatility should create buying opportunities.

Bank Macro Manifest: Rates to Remain Risk Asset Challenging; Take Carry Opportunities

Asia High Yield Bond Index

Bank Macro Manifest: Rates to Remain Risk Asset Challenging; Take Carry Opportunities