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Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

The risk-on rally gathered steam as a lower than anticipated U.S. jobs report added to a confluence of pressures already driving the U.S. yield curve steeper. The jobs report added to the narrative that additional US federal stimulus is needed. This confirmed the risk-on sentiment.In addition to stimulus expectations, hedging activity in the swap market may also be driving rates higher as insurance companies immunize equity gains and short positioned investors grab protection. Ten-year and 30-year yields rose 10 and 14 basis points, respectively, week-on-week to end at 1.17% and 1.97%.Concurrently, carry considerations amid low repo rates are driving short-end rates lower. Excess liquidity and the expectation of even more liquidity aided in collapsing overnight interest rates and driving two-year yields to record lows. Investors that focus on high-quality short-term securities may be pushed further up the curve to grab yield.  This flood of cash could drive credit spreads even lower.Meanwhile, US Treasury supply prospects in the short term are dropping. The Treasury indicated that it would reduce its cash balances in half, to $800 billion by the end of March, followed by a further cut of $500 billion by the end of June. This should boost bank reserves sharply, depress money market rates and likely provide a boost to risk assets as investors reach further out the curve to remain invested.Upward pressure on the long-end combined with downward pressure on the short-end to steepen the Treasury curve materially. Bank stocks jumped in response to the weakness in long-end Treasuries and the steeper yield curve that resulted. Once again this showcases the high correlation between rates and equity value.In this environment, U.S. CCC-rated and Asia High Yield (HY) index spreads tightened. CCC’s jumped 64 basis points (bps) tighter week-on-week while Asia HY walked-in 14bps. US HY credit should have limited upside in a reflation scenario and a delay should benefit Asia-headquartered risk assets. Therefore, we wonder if we are witnessing the opposite.Market Outlook: The catalyst for a correction is outsized fiscal stimulus combined with overly accommodative monetary policy. Near-term, stimulus materially greater than $1 trillion may arrest short-end yield-compression. Short rates could rise, and this may not be bank valuation positive. Longer term, former Treasury Secretary Larry Summer’s warning on using valuable fiscal space may come back to haunt if inflation outpaces the recovery in credit fundamentals. This would not be EM credit valuation positive.

The risk-on rally gathered steam as a lower than anticipated U.S. jobs report added to a confluence of pressures already driving the U.S. yield curve steeper. The jobs report added to the narrative that additional US federal stimulus is needed. This confirmed the risk-on sentiment.In addition to stimulus expectations, hedging activity in the swap market may also be driving rates higher as insurance companies immunize equity gains and short positioned investors grab protection. Ten-year and 30-year yields rose 10 and 14 basis points, respectively, week-on-week to end at 1.17% and 1.97%.Concurrently, carry considerations amid low repo rates are driving short-end rates lower. Excess liquidity and the expectation of even more liquidity aided in collapsing overnight interest rates and driving two-year yields to record lows. Investors that focus on high-quality short-term securities may be pushed further up the curve to grab yield.  This flood of cash could drive credit spreads even lower.Meanwhile, US Treasury supply prospects in the short term are dropping. The Treasury indicated that it would reduce its cash balances in half, to $800 billion by the end of March, followed by a further cut of $500 billion by the end of June. This should boost bank reserves sharply, depress money market rates and likely provide a boost to risk assets as investors reach further out the curve to remain invested.Upward pressure on the long-end combined with downward pressure on the short-end to steepen the Treasury curve materially. Bank stocks jumped in response to the weakness in long-end Treasuries and the steeper yield curve that resulted. Once again this showcases the high correlation between rates and equity value.In this environment, U.S. CCC-rated and Asia High Yield (HY) index spreads tightened. CCC’s jumped 64 basis points (bps) tighter week-on-week while Asia HY walked-in 14bps. US HY credit should have limited upside in a reflation scenario and a delay should benefit Asia-headquartered risk assets. Therefore, we wonder if we are witnessing the opposite.Market Outlook: The catalyst for a correction is outsized fiscal stimulus combined with overly accommodative monetary policy. Near-term, stimulus materially greater than $1 trillion may arrest short-end yield-compression. Short rates could rise, and this may not be bank valuation positive. Longer term, former Treasury Secretary Larry Summer’s warning on using valuable fiscal space may come back to haunt if inflation outpaces the recovery in credit fundamentals. This would not be EM credit valuation positive.

Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus

Asia High Yield Bond Index

Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus