Choisissez votre langue

Search

Renseignements

Aucune correspondance

Services

Aucune correspondance

Secteurs d’activité

Aucune correspondance

Personnes

Aucune correspondance

Renseignements

Aucune correspondance

Services

Aucune correspondance

Personnes

Aucune correspondance

Secteurs d’activité

Aucune correspondance

New Year, New Range? - High Quality Credit Spreads

FICC Podcasts 13 octobre 2021
FICC Podcasts 13 octobre 2021


Disponible en anglais seulement

Dan Krieter and Dan Belton discuss four factors likely to bring a new, wider range in credit spreads in 2022 including inflation/growth concerns, monetary policy, fiscal policy, and technicals. Other topics include recent norms for credit spread ranges.


Follow us on Apple Podcasts, Google Podcasts, Stitcher and Spotify or your preferred podcast provider.


About Macro Horizons
BMO's Fixed Income, Currencies, and Commodities (FICC) Macro Strategy group led by Margaret Kerins and other special guests provide weekly and monthly updates on the FICC markets through three Macro Horizons channels; US Rates - The Week Ahead, Monthly Roundtable and High Quality Credit Spreads.

Podcast Disclaimer

LIRE LA SUITE

Disponible en anglais seulement

Dan Krieter:

Hello, and welcome to Macro Horizons, high quality spreads for the week of September 29th, making the case. I'm your host Dan Krieter here with Dan Belton. As we reach an inflection point in credit spreads, we debate the near term path for credit and swap spreads as well as what are likely to be the most important drivers between now and the end of the year. Each week, we offer our view on credit spreads, ranging from the highest quality sectors, such as agencies and SSAS to investment credit corporates. We also focus on US dollar swap spreads and all the factors that entails including funding markets, cross currency markets, and the transition from library to sulfur, the topics that come up most frequently in conversations with clients and listeners form the basis for each episode. So please don't hesitate to reach out to us with questions or topics you would like to hear discussed. We can be found on Bloomberg or email directly at dan.krieter, K-R-I-E-T-E-R, @bmo.com. We value and greatly appreciate your input.

Speaker 2:

The views expressed here are those of the participants, and not those of BMO capital markets, it's affiliates or subsidiaries.

Dan Krieter:

Well, Dan, before jumping into Making The Case episode, I think it's worth discussing the path of credit spreads in just the past week or week and a half, which has actually stood out as quite important. Last week ends up being the best performance for credit spreads on an index level since early April. And that happens despite what we probably consider some risk off factors, including first the evergreen storyline, which we saw volatility on the back of that last week. And that's still sort of lingering. And secondly, a more hawkish than expected FOMC, which we discussed in length in our podcast last week. And despite these factors, we saw index spreads narrow three and a half basis points either to or very close to the cyclical lows established at the end of June. And I think this really bears out some of the things we've been arguing for the past couple of weeks.

Dan Belton:

Yeah, Dan. We've been talking a lot, not just the past few weeks, but really a lot of this year about the resilience in credit spreads. And I think that was also on display yesterday when we saw equity spend most of the session down 1% to 2%. and actually despite a heavy issue in slate, credit spreads only widened by one basis point. We continue to see this seemingly limitless demand for credit, and I think that's been on display the past couple of weeks.

Dan Krieter:

Yeah. I agree with you. And to specifically focus in on one topic, it's the tapering topic which we talked about last week. We saw the FOMC, both bring tapering as early as they really possibly could have, as well as announced plans to taper more quickly than anyone was expecting. And yet that still didn't really matter for credit. It just speaks to the idea that we've been espousing for a while, that the announcement of tapering really shouldn't matter. And even the details shouldn't matter. And even when you see them come as hawkish as they could have, spreads actually just continue to narrow through because the announcement of tapering, it's not going to make a taper tantrum this time. We do have concerns which we've talked about about the impacts of the actual mechanics of tapering and credit down the road, but the announcement shouldn't matter. None of it has.

Dan Krieter:

And we were pretty firmly in the case that spreads would continue to narrow through heavy September supply. That bit of a soft patch we saw on August would prove to be a technical weak point where demand just seasonally fell off. And we saw a bit of pockets of heavy issuance or heavier than normal issuance for the type of year in early August. And we just saw sort of this technical, weak patch, which has given way to a resumption of narrowing once everyone's back in their seats.

Dan Krieter:

Well now, sitting here at the end of September, we've been maintaining the 75 basis point target on credit spreads for the early to mid part of quarter four. And with those levels now in sight, I thought it'd be really interesting today, Dan, if we dusted off another one of our Making The Case episodes. Now that we're in the shouting range of our spread target, we can discuss what our view is going to be say between now and the end of the year. Where one of us will argue for spreads to continue narrowing, and the other one will argue for spreads to go wider. And I guess I can start by asking you which side would you like to argue?

Dan Belton:

I will take the bullish side on spreads.

Dan Krieter:

Okay. That leaves me a bit more bearish and a peek behind the curtain here for our listeners. This does line up with the way we really are feeling. Obviously Dan and I talk about spreads every day. And we're often in agreement. We're starting to diverge here a bit where I'm getting more cautious in the medium term looking into the end of this year and beyond into 2022, but Dan continues to be extremely bullish on credit spreads. So we figured it would be a good time for this Making The Case episode. And I'll start by making the case, Dan here, just by talking about the recent move in treasury yields, which I think has happened more rapidly than perhaps we were expecting.

Dan Krieter:

And it really just starts to degrade the relative value proposition of spread products, like the ones that we track. And just to put it quickly into numbers, after last week's narrowing in IG and the big move higher in treasury yields, yield enhancement on the IG index is now somewhere around 53%. And that's actually below average. Going back to the beginning of daily publication of index spreads back in 2002, the index is average yield enhancement of 46%, but what's likely the more applicable comparison is that post-crisis periods, say between 2013 and 2019, where we saw heavy central bank intervention, low volatility, low yields, which combined to create a very strong yield grab environment. And even during those years, which is 2013 and 2019, the average yield enhancement of the index was 56, 57%. So we're now tighter in terms of yield enhancement than even during that 2013, 2019 range.

Dan Krieter:

And we are starting to see some more concerns about inflation continue to come to the surface. We were all talking about inflation, it seems like, two or three months ago. And then everything sort of died down. We're starting to get some prints that indicated that inflation's transitory nature was being born on it and that it was going to slow down, but now people are starting to get more worried about inflation again. The treasury curve flattening may have run its course. We may even start to see some steepening now. And I think inflation concerns from a credit perspective are bad in two ways. First, we could see continually higher treasury yields, which puts upward pressure on credit spreads and also inflation itself, particularly with the weak consumer like we think we have now, inflation could be a credit story for corporations that struggled to pass along the increased cost of inputs, ultimate result again, compress profit margin. So I think the return of inflation and higher treasury yields really works against continued spread narrowing here in the near term.

Dan Belton:

Yeah, Dan. So I'll start with your point about treasury yields. And I agree that over the long-term, higher treasury yields definitely do correlate with wider credit spreads. We see that in our econometric models for credit spreads. Just historically, that has typically been the case. When we are in a low rate environment, we typically see narrower spreads and vice-versa. However, this is decidedly more of a long-term trade-off. When we look at these episodes in which treasury yields are rising, we don't necessarily see under-performance in credit. In fact, it's actually quite the opposite. So we've gone back and looked at the past nine episodes of sustained moves higher and treasury yields. We found that in six of them credit spreads narrowed significantly and only in three did credit spreads really underperform during these moves wider and treasury yields. Those three episodes were 2005 to 2006, 2013, and then 2018.

Dan Belton:

Each of these episodes had one significant factor in common and that was a Fed that was starting to choke off monetary accommodation. In 2005 to 2006, you had the Fed hiking Fed funds rate all the way up to five and a quarter percent. 2013, of course, was the taper tantrum. And then 2018, again, the Fed probably hiked a little bit too far and then ended up having to give back some of these hikes in the form of those insurance cuts. So if the Fed is not removing accommodation, typically during periods where treasury yields are moving higher, credit spreads do end up well bid. Over those nine episodes that I talked about, on average, including the three in which credit spreads underperformed, we saw credit spreads narrow on average by 25 basis points. So for that reason, I think there is more room, at least, in the near term for credit spreads to remain well bed.

Dan Belton:

I don't necessarily see a significant move narrower in credit. Credit spreads, yes, like you said are already pretty narrow, but I do think there's a little bit more room to go. And if I'm an investor here, I'd rather be low on credit than sitting in cash or in treasuries right now, waiting for a widening that might not come for another year or so. Now, you brought up a good point with respect to inflation. That does pose a real threat to credit, but given the amount of liquidity in the system, I don't see an event on the horizon mirroring the 2020 experience where there's iliquidity and investors are just unable to get out of their positions. I think if we did see sustained inflation that truly proved a credit event, that would be a long and slow moving process where credit investors would be able to reduce their positions in an orderly manner.

Dan Krieter:

Okay. Lots to respond to there. I guess I'll start by this. I'm not going to push back on your assertion that we could see some near-term narrowing. I sort of agree with that. I think for at least the course of the next say month or so, I think credit conditions are going to remain very supportive. I don't know if that will get significant narrowing, but it wouldn't surprise me to see range-bound credit spreads even a continued grind narrower towards 75, whether or not we actually read 75 or it stalls out at 79, 78, 77. That remains to be seen, but we're talking single digit basis points here. But you brought up a couple things that I want to talk about and potentially present as part of the rationale for why spreads will widen going forward. And specifically you talked about two things.

Dan Krieter:

The first one being, I think you made a great point about the last few times when spreads moved wider that happened to coincide with the Fed tightening monetary policy. I think that sort of applies to today. Obviously, we're not going to see the Fed tightening monetary policy, but we are going to see the tapering of asset purchases, which plays directly into the second fact you talked about, which was reserves in the financial system and monetary accommodation. I think this is an extremely important point. And the more we think about credit spreads and what drives them, the more I'm beginning to think that the amount of financial reserves in the system pushing on the so-called portfolio channel of QE, where investors are just pushed out the credit and maturity spectrum by the central bank pushing financial [inaudible 00:10:33] system. The more I think that is having a really large impact on the path of credit spreads and other risk asset valuations for that matter, but looking myopically at credit spreads now, and we are going to see that start to change.

Dan Krieter:

We talked about this a couple of weeks ago in our As Good As It Gets podcast, but beginning with the debt ceiling resolution, which we now know will likely have to happen by mid-October, with secretary Yellen's most recent guidance on when that X date is, we're going to see the treasury run its cash balance. And that's going to equate to a $600 billion to $700 billion removal of financial reserves from the system, which we've only been positive inflows since March of 2020. We're going to see $700 billion of reserves removed from the system for the first time. And then that's going to basically transition directly into the end of quantitative easing. We're going to see the Fed taper asset purchase and ultimately stop the growth of reserves in the financial system by the mid point of 2022. Now, I don't think that that's going to cause a large widening in credit spreads.

Dan Krieter:

That's not the point I'm making, but I do think that this stock versus flow argument, we're going to see still a very heavy stock. And that's going to keep spreads at the narrow end of historical trading ranges. But the change in the flow from still very large influx to negative, and then just sort of neutral, I think that's going to rob credit spreads of their narrowing potential to continue narrowing further. I think we might be reaching a point that's going to be the cyclical low in credit spreads given the path of financial reserves. And at that point, all it takes for a widening is some concern on the macro front, and that could come from a few different factors. It could come from COVID, it could come from China or something we don't currently see. In my view, it's sort of... You need two things for a widening and the first one we're going to reach in the next couple of months.

Dan Belton:

So Dan, let's go back to the topic of tapering real quick, because I agree that is at the forefront of the market narrative right now. So if we go back to the 2013 experience, when the Fed last tapered, let's look at the performance of credit spreads during that time. So let's call it the Eve of the taper tantrum, May of 2013. Right before treasury yields started to sell off and credit spreads started the widen, the Bloomberg Barclays index was at about 130 basis points. It peaked in middle of summer of 2013 at 155 basis points. And then really retraced most of that widening. And most people, I think, were in this camp would agree that that moved the taper tantrum or the reaction in credit to the taper tantrum was probably overdone and unlikely to be repeated this time based largely on learned experience from that time.

Dan Belton:

So credit actually after the taper tantrum, once the Fed started tapering in December of 2013, credit spreads were back at around 130 basis points in the Bloomberg Barclays index. They then narrowed about 35 basis points and hit lows of 95 basis points in the middle of 2014 while the Fed was still tapering. And while that tapering was pretty far along, they didn't really widen back out significantly until the Fed just about it stopped tapering. I'd say in September of 2014, that's when the impact of Fed tapering started to really weigh on spreads when the Fed was only buying about $25 billion or so a month. So I agree with your point that the Fed, once it starts to remove this accommodation, is going to start to weigh on credit spreads. I just don't think we're there yet. And I think if the last time around is any indicator, we could be another year or so from that starting to really weigh on credit.

Dan Krieter:

But there's also another key consideration in that taper tantrum that we have to talk about. And that is, we saw the taper tantrum, which like you said, was more contained to treasury markets than it was spreads and we saw the big back of the treasury yields, but then after the taper tantrum, treasury yields continued to fall and fell really through the next basically year plus, year and a half until the end of 2015. And I think that's going to be potentially a key difference. At the end of QE, announced at the end of 2013 and then ultimately asset purchase ended at the end of 2014, there was not this idea that we were going to have a robust economic growth and inflation might run away. It was that we're going to be in this very low growth, low rate environment for a while. And that's going to be when you're going to see narrow credit spreads.

Dan Krieter:

So I guess it's transitioned the conversation a bit towards the macro outlook, but we're at a different place right now. Rates have been in a historical low trading range for the better part of a year and a half now. And we're starting to see some optimism here that we're going to actually have growth and potentially inflation. And it's that inflation piece that's a differentiator and I think what could really spark a widening and credit spreads if we actually see inflation. There was none of that in 2014. And also, I want to say that I think supply is going to matter here. And actually taking a step back and just look at things more holistically, it just feels to me like there's more optimism at this point than there was at the end of 2014, end of 2013 and 2014.

Dan Krieter:

If we get anything that disappoints from even an inflation or not kind of a growth perspective, it seems like spreads are exposed to that. Whereas back then, there wasn't a ton of optimism. It was more like this muddle through scenario and just grab some meals here and there. It doesn't feel the same to me. And also, I'll just want to comment also on corporate supply, which has been historically heavy now for, what? I mean, the past year and a half. Last year was a record, this year is going to be a record for any year, not including last year. And there's not a ton of reason to expect that to change. Yes, I think that the pace of corporate supply will slow. We've seen a lot of liability management this year.

Dan Krieter:

That's going to slow down, but corporations nowadays are seemingly mandated to try to return money to their shareholders. And a lot of that is share buybacks that oftentimes are fueled with debt. We're going to see that continue, and next year I expect to see a little bit more investment into businesses. This whole just return money to shareholders thing. It's going to change. We're going to see some more investment, some more cap backs that's just natural [inaudible 00:16:39] at this stage in the economic cycle of recovering from a major recession. And we're looking at gross versus net. I think gross corporate supply could continue to be similar to this year. We're going to have about, what? $1.3, $1.4 trillion looking ahead to next year.

Dan Krieter:

I think that could be similar, but from a net perspective with less liability management next year, we're going to see higher net corporate supply next year and we're going to see less financial reserves into the system where the Fed is just creating money that all this corporate supply can then go into. We're not going to have that money creation next year. We're going to have to have people actually buying this corporate supply. So whereas you described it earlier in the podcast, is limitless demand, well, it's limitless because of how much money the Fed's pumping into the system. With that turned off, there are going to be limits. And it could start as early as January in my view when we get back to always have the best issuance month of the year and not as much reserves coming into the system.

Dan Belton:

Yeah, Dan. You raised some interesting points and I think we're pretty similar in a lot of them, maybe with the major difference being the timing of when they'll take effect, but I want to go back to what you said about the difference between a low growth environment and a strong growth environment. And I think there's a lot of uncertainty still about what environment we're going to be in going forward. But for the sake of our argument, why don't we say this is going to be a stronger growth period than we had following the financial crisis? I think there's a few mitigating factors that would cause credit spreads to be pretty well contained in such an environment. The first is of course, fundamentals. And fundamentals are as strong as they have been in at least three years, probably longer in some dimensions. Your net rating actions at the index level are extremely constructive.

Dan Belton:

We've had virtually no downgrades for the past several months. And while that might slow down in the medium term, that might moderate a little bit, as long as the fundamentals hang in, they should remain a tailwind for credit spreads. And we've seen great improvement in recent quarters from a standpoint of financial leverage and that's lower than it's been at any point since the onset of the pandemic. As long as we're in a strong growth environment, I think that's going to remain the case. In a higher rate environment that's caused by strong growth, I expect all in yield buyers to step in and be a strong source of demand for credit. I think that's part of what we've seen in the past couple sessions as treasuries have been selling off.

Dan Belton:

And lastly, I disagree a little bit about your assertion with technicals. Particularly yesterday when we saw equities down 1% to 2%, as I mentioned at the beginning of the podcast, we had nine borrowers come to market. Only about two or three stands downs, and they came and borrowed $12 and a half billion. Now I think, in other environment where you just saw equities down 1% to 2%, you would probably have a lot less issuance in the market. But given that there was this expectation that rates are going to be higher, you had a lot of borrowers coming to market because they thought this might be the last best chance to lock in these low rates. And to me, that's a sign of lower borrowing needs in the future as this wave of refinancing would likely subside if we had higher rates going forward.

Dan Krieter:

Yeah. And we've gotten this far on the podcast. We have even talked about equities. You mentioned it here. Equity is near all time highs and you're hearing more and more chatter about a potential correction in equities. And if we have a 10% correction in equity or something like that, credit spreads are not going to perform through that. Sure, they might outperform equities from a risk asset perspective. They don't widen as much as they may have another 10% corrections at equities, but they will widen it in a 10% equity correction. And that's another wild card I want to talk about here, which is the potential of regulation. Particularly in 2022, once we replace Randy [Quarrels 00:20:20] as vice-chair of supervision and we bring in what's presumptively going to be someone a bit more hawkish on the regulatory front, potentially Brainerd, who I guess now is getting chatter as a new chairman.

Dan Krieter:

But regardless of who it is, we're going to have somebody with more hawkish regulation view. And that could mean money market reform. That could mean reform on shadow banks. That could be more reform on the corporate bond market itself. How trades are reported, things of that nature. And more regulation just from any one of these and potentially multiple of them is likely going to be a negative for equities. And that goes without saying any of the other risk factors currently facing the market. I mean, COVID has taken a pretty best case scenario here in the past couple of weeks, which is great news for everybody involved, of course, but there's certainly still potential for that to wobble sideways at some point here, another very interest, something like that. I just think the argument for credit spreads to continue narrowing, you need such a narrow path.

Dan Krieter:

Everything needs to kind of proceed along so perfectly. Now, I will just, I guess, equivocate a little bit here by saying, in the absence of a sustained pickup in inflation, wage inflation, so market participants starts to price in a less transitory inflation spike, we're going to see basically an inflation cycle here where we see wage gains that increase prices and that becomes a self-fulfilling cycle. Unless that happens, I think you're going to have a hard time seeing credit spreads move to a much, much higher trading range. I think we're going to be obviously on the low end of the historical range, it's just going to be where are we going to define that range. Is 75 and 80 basis points going to be the low of that range in 2022? I personally don't think so.

Dan Krieter:

I think, as we look ahead to next year, we're going to see higher treasury yields, we're going to see more concerned around technicals of on taking down the supply with financial reserves dropping and we're just going to see a new ranging credit. Maybe instead of 80, it's going to be 90 or 95 basis points. That's why I'm saying, it's just a bit of a shift and I expect that to take place, really beginning to start... Toward the end of this year. When we see TGA start to run up its cash balances and we see the $700 billion outflow on reserves, that could... For the first time we see a little bit of crack in credit. And particularly given this time of the year where we see investors keen to lock in profits, potentially, not be so active.

Dan Krieter:

We're not going to see maybe as much dip buying with everyone expecting very, very large issuance come January. We won't see people maybe jumping into buy any dip in credit. I think you could get toward the end of the year, say November, I can see a five to 10 basis point backup. And then heading into next year, that sort of becomes the watermark that we're going to base the year off of. That's really all I'm saying is that I think looking past the really near term constructive environment on the next month, we could just see a 10 to 15 basis point backup that's going to redefine where credit trade's going forward.

Dan Belton:

Yeah, Dan. I think big picture we're not too far off from each other. I also expect to see that back up at some point in the future. I just don't expect it until maybe the first or second quarter of next year. Well, Dan. I think that pretty much covers it. Anything else?

Dan Krieter:

No, we will be off next week. We have a round table macro podcast with the entire team. So we'll be back here on high quality spreads in two weeks. And I guess this will be our chance to tell everyone to enjoy the long holiday weekend next weekend, and we'll see you in a couple of weeks.

Dan Belton:

Thanks for listening. Thanks for listening to Macro Horizons. Please visit us at bmocm.com/macrohorizons. As we aspire to keep our strategy efforts as interactive as possible, we'd love to hear what you thought of today's episode. Please email us at daniel.belton, B-E-L-T-O-N, @bmo.com. You can listen to this show and subscribe on Apple Podcasts or your favorite podcast provider. This show is supported by our team here at BMO, including a FICC Macro Strategy Group and BMO's marketing team. The show has been edited and produced by Puddle Creative.

Speaker 2:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Incorporated and BMO Capital Markets Corporation. Together, BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments.

Speaker 2:

We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or a suggestion that any investment or strategy referenced herein may be suitable for you. It does not take into account the particular investment objectives, financial conditions, or needs of individual clients. Nothing in this podcast constitutes investment, legal, accounting, or tax advice, or a representation that any investment or strategy is suitable or appropriate to your unique circumstances, or otherwise constitutes an opinion or a recommendation to you.

Speaker 2:

BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures contracts, and commodity options or any other activity which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the US Commodity Exchange Act. BMO is not undertaking to act as a swap advisor to you, or in your best interest in you to the extent applicable, you will rely solely on advice from your qualified, independent representative in making hedging or trading decisions. This podcast is not to be relied upon in substitution for the exercise of independent judgment. You should conduct your own independent analysis of the matters referred to herein together with your qualified independent representative, if applicable.

Speaker 2:

BMO assumes no responsibility for verification of the information in this podcast, no representation or warranty is made as to the accuracy or completeness of such information, and BMO accepts no liability whatsoever for any loss arising from any use of or reliance on this podcast. BMO assumes no obligation to correct or update this podcast. This podcast does not contain all information that may be required to evaluate any transaction or matter and information may be available to BMO and, or its affiliates that is not reflected here in.

Speaker 2:

BMO and it's affiliates may have positions, long or short, and affect transactions or make markets, in securities mentioned here in, or provide advice or loans to or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, BMO's trading desks may have acted on the basis of the information in this podcast. For further information, please go to bmocm.com/macrohorizons/legal.

 

Dan Krieter, CFA Directeur, Stratégie sur titres à revenu fixe
Dan Belton Vice-président - Stratégie sur titres à revenu fixe, Ph. D.

Autre contenu intéressant