Church House CEO Jeremy Wharton gives his usual in-depth summary of credit markets across the globe.

Thin end of December trading exacerbated moves in the fixed interest markets, some of which have subsequently been retraced. It had felt that markets had got a little ahead of themselves and we were due some retrenchment of what turned out to be a strong end to 2023. These moves must be viewed in the context of what is an uncertain geopolitical and economic backdrop. But markets are still fixated on the path of interest rates and, after recent data, have moved quickly to discount hopes that we have seen the peak in the hiking cycle and terminal rates have been found. The markets are not necessarily listening to what Central Bankers are actually saying.

The risk of Middle Eastern tensions stepping up to another level is real and it has been widely broadcast that over 40% of the world’s ‘democratic’ population face elections this year, not least the US and the UK. Undemocratic societies have their own set of problems. China, following hard on the enormous defaults of its two biggest property companies, Evergrande and Country Garden, saw their property debt crisis take hold in their shadow banking sector. This is roughly $3trn in size {the same as the French economy) so the filing of Zhongzhi for bankruptcy with $64bn of liabilities is relatively small, but the risk of contagion is high {thankfully most of these liabilities are contained in onshore China).

Members of the Federal Reserve did their best to push back against the most optimistic and exuberant forecasts of almost immediate cuts in rates. Acceptance of ‘higher for longer’ was replaced with fears of ‘too high for too long?’. Either way, the US ten-year Treasury Bond saw a move in yield of over 1% from near 5% to below 4%, a level not seen since July. As much as rates markets incorrectly discounted the speed and severity of the hiking cycle, they are likely to overestimate the timing and depth of the easing cycle. Commentators have sensibly reminded us of one rule that still holds as true as ever: Don’t Fight the Fed...

The reality of funding the US budget deficit has hit home. $6trn is a big number and that is what the Fed has to raise from sales of Treasury-Bills {very short-term debt). Simply funding through T-bills is not possible, so longer-dated debt has also had to bear the brunt of a trillion dollars of new issuance. Longer-dated volatility meant the US thirty-year fixed mortgage rate rose to 7.92%, a major part of the US housing market. Activity fell off a cliff as supply was stifled by existing mortgage holders having no wish to move and refinance at these levels. These rates have since fallen back but remain elevated.

The European Central Bank {ECB) has to watch and help Eurozone member states maintain a collective debt to GDP ratio of more than 91% over the funding period. Bear in mind that while this is going on, central banks are attempting to shrink their balance sheets, removing them as the marginal buyer of new issuance.
The ECB also has the unenviable task of trying to navigate their way through a potential recession that might already be upon them as their Purchasing Managers Indices {PMIs) remain below 50 {a reading below 50 is contractionary) for the seventh month in a row. German inflation popping up to 3.7% from 3.2% in December, France also seeing a rise from 3.5% to 3.7%, won’t be helping them. Some ECB members have warned that ‘no one should count on rate cuts this year’.

The Bank of England’s thinking has become more ‘data dependent’, which will dictate the ‘path of rates’ according to deputy Governor Ramsden; I would have thought this is always the case. Politics intrude as the General Election appears on the horizon and Rishi Sunak states that now ‘he’ has achieved a halving of inflation ‘we can begin to cut taxes’, however the Autmn Statement had little material in the way of tax reductions, so we look forward to the Budget.

The UK appears to have shaken off the ‘stagflation’ label as we saw strong year end growth (PMI’s well above 50 and a November GDP print of 0.3%) but stagnation (or even recession) remains a risk. There was much navel gazing as the FTSE 100 Index celebrated its 40th birthday, having had a miserable 2023 compared to its peers, but we do look to be in a healthier position than some of our near neighbours. The Bank has also attempted to push back against market expectations of five rate cuts this year. We must remember that rates were normalised from an artificial low point so, unless we see a marked drop-off in activity leading to a sharp recession, we are unlikely to go so far so fast.

The primary market {where companies and governments come to the market to borrow) had a busy fourth quarter and then exploded into life in the New Year for both sovereign and corporate issuers. There has been healthy demand for government bonds, which is reassuring, the new UK twenty-year Gilt issue was 3.6 times oversubscribed and even Italy’s seven-year issue was seven times oversubscribed.

In sterling credit, high grade corporate issuers were busy accessing the market and the interest yields on offer for the lenders {investors) are still highly attractive with New Issue Premium {NIP) allowing for outperformance in the secondary market. Fundamentally sound credits offer returns that are more predictable than they have been for years. We do not believe investors should, or need to, compromise credit quality by going down the food chain into high yield {HY) bonds, especially as one can achieve high yields in Investment Grade issues. There is a HY refinancing ‘hump’ coming in 2025 and a fair number of companies will struggle to refinance, or, if they manage to, they might have to pay penal rates to do so.

The full Quarterly Review is available here

January 2024


Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.

Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.


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