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Sizing September Supply - High Quality Credit Spreads

FICC Podcasts 02 septembre 2021
FICC Podcasts 02 septembre 2021

 

Disponible en anglais seulement

Dan Krieter and Dan Belton discuss what to expect with respect to the coming wave of issuance following the long weekend and how the market will absorb the new supply. Other topics include the important role that fiscal policy will play in coming months.


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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.

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Disponible en anglais seulement

Dan Krieter:                                           Hello and welcome to Macro Horizons High Quality Spreads for the week of August 31st, Sizing September Supply. I'm your host Dan Krieter here with Dan Belton, as we discuss the issuance wave that's certain to hit IG markets starting next week, as well as discussing some other factors that we think will drive credit spreads in the near term. Each week, we offer a view on credit spreads, ranging from the highest quality sectors such as agencies and SSAs to investment grade 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 LIBOR to SOFR. The topics that come up most frequently in conversations with clients and listeners form the basis for each episode. 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.

Disclosure:                                            The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Dan Krieter:                                           Well, Dan, August this is finally over. By the time you're listening to this, it's now officially September and the last three weeks of really no volume will finally come to a close. Supply is going to return to the markets next week. We'll get to that later in the podcast. But I guess we could start with what's happened since our last episode. Not much. We did see credit spreads turned narrower. The ICE BofAML index narrowed three basis points over the course of last week.
                                                       That's the best weekly performance we've had in about two months here, so that's certainly good news. I think we can chalk a lot of it up to what happened at Jackson Hole, which ends up being sort of a non-event.

Dan Belton:                                            Yeah, it was. Really the real risk we talked about heading into Jackson Hole was that the Fed talked up the potential for a September taper. And as we had heard hawkish FOMC members before the Jackson Hole symposium, credit spreads underperformed as that scenario was talked about. But Chair Powell I think pretty definitively put the taper timeline announcement in the November-December area. Credit spreads outperformed on that. I think technicals also played a role in the narrowing we saw last week.
                                                       Again, the second straight week of very light supply. This week, it's been more of the same, just very little issuance, very little secondary market activity.

Dan Krieter:                                           We talked last week a bit about how spreads was seemingly becoming more responsive to tapering timelines and how we weren't really convinced that's really what was going on. I'm sort of still in that same camp. And even if we were seeing reactions to it, I think now with Jackson Hole in the rear view mirror and really I think no real chance that we're going to get a tapering announcement in September, I'm with you. They would have had to strongly message that at Jackson Hole if that was going to happen. It's back to November-December.
                                                       I think now there's almost no chance it gets pushed out further than that. We know the timeline of tapering now. Maybe there's still some unknowns around how long they're going to taper or whatever, but I don't see that mattering for credit, particularly with the Fed now very explicitly... And this was the main goal of what their messaging at Jackson Hole was trying to accomplish. They have explicitly separated tapering from any talk of liftoff for the beginning of a hiking campaign, even going so far as to say the tapering is not even a step towards liftoff.
                                                       It's just taking their foot off the accommodation gas pedal. Now obviously the next big thing from a monetary policy standpoint will be, when are they going to consider raising rates? Not soon. I don't think 2022 that's even on the table. We're talking 2023 at the earliest for a rate hike. I think we can do at least a certain extent sort of put central bank policy to bed here. I don't really see it being a very significant driving force for credit say over the next few months until the end of the year.
                                                       If it's not going to be central bank policy that's impacting credit spreads, I think it's really two factors that's going to be... The first is technicals, which you alluded to a little bit, and the second one I think is going to be the evolution of fiscal policy, in particular stimulus between now and the end of the year, with lawmakers in DC with a lot on their plates to figure out between now and when everybody goes home for Christmas. We'll talk about that maybe towards the end of the podcast.
                                                       Let's start with what's most immediate for high-grade investors here and that's going to be the September supply wave starting next week. Dan, I guess we'll start here. You're expecting us to get off to a pretty quick start, huh?

Dan Belton:                                            Yeah. We're projecting about 140 billion in gross issue in September for just IG corporates alone. And typically what we see in September is very front-loaded issue. It won't be unlike what we saw in August. We wouldn't be surprised to see about a hundred billion or so in the first two weeks after Labor Day. And that's typically about what we see. On average, in September when the FOMC falls two weeks after Labor Day, as it does this year, we see about 70% of September supply in just those nine sessions between Labor Day and the following Friday.
                                                       If we saw that dynamic play out again, we would probably see something in the realm of a hundred billion or so in issuance in the first two weeks of the month.

Dan Krieter:                                           140 billion is the projection, Dan. I'm curious, how does that slide in when we compare it to historical years regarding supply in September?

Dan Belton:                                            We're actually expecting something of a slowdown from recent Septembers. In 2019 and 2020, we saw about 161 and 170 billion respectively. But before 2019, 140 would have been pretty much in line with recent averages. What I would say about that is that our 140 billion projection is higher than some of the median estimates that we've seen on the street, but there is still some upside risk to that figure.
                                                       And what we'll be watching with respect to that risk is how does supply come out right out of the gates after Labor Day, on that Tuesday and Wednesday, because we're expecting really, really strong supply in those first few sessions. How strong does it come, and then we might see some of that risk realized.

Dan Krieter:                                           And then obviously taking it full circle to bring it back to the impact on spreads, you talked about how is supply going to be in those first couple of days. I'll be watching with interest what the demand statistics look like in those first couple of days as well. Because I'll just say anecdotally here in my client conversations over the course of August, I couldn't help but get the feeling that the sense from the buy-side was that there was going to be very, very heavy issuance come September. Bordering on record issuance.
                                                       It's not hard to see why. We've had record issuance for the majority of 2021 here. Obviously September, typically one of the most liquid months of the year, we've seen COVID start to build on some uncertainty with the Delta variant again. We've seen rates come low, so there is some refinancing needs here. There's still been nothing on the SLR front, so financial issuance should remain very, very heavy. The drivers that have been placed all year that have driven to this point record supply remain in place to at least some extent here.
                                                       It's not hard to see why you'd be expecting record supply, but we're not really expecting that. If we see demand expecting massive issuance, and we only get historically average issuance, which just to be very clear is still heavy, but in the context of what the market's expecting, I think that September supply could end up being somewhat lighter than expectations, which would indicate to me that the market is ready and willing to digest that supply and that we can see spreads continue to perform through that supply.
                                                       That's how I'm looking at it from a high level, but maybe it's worth taking a moment here, Dan, just looking at the $140 billion forecast in a bit more detail. Given the record pace so far of 2021, what drivers are you seeing that's making you expect just average issuance in September?

Dan Belton:                                            Dan, this has been sort of part of our forecast for issuance for the year as a whole, which we were expecting really front loaded, heavy issuance throughout 2021, and we've seen that. We've seen nearly record issuance with the exception of 2020. '21 supply year to date has been a record. And then we've been long expecting for supply to slow down a little bit as economic clarity continued to unfold. We got more fundamental strength from corporates.
                                                       And as we've talked about on this podcast, a couple of times recently, corporate fundamentals as seen through balance sheets has improved significantly in recent quarters. We expect that to continue, and we expect some amount of de-leveraging to continue to unfold. Yes, 140 billion is not light by any means, but it would represent just a more gradual continued return to a normal funding needs. I just want to go back quickly to your point about how investors are certainly setting up for strong September supply as they have traditionally.
                                                       Early September is typically one of the strongest, if not the strongest supply periods of the year. And even though we might see slightly higher new issue concessions in order books that reflect some of this heavy supply, we're not expecting that this supply is going to overwhelm the market by any means. We have seen record issue in sellers ready this year and the market has taken it down by and large with a great deal of enthusiasm.
                                                       One parallel I would draw as to this period in 2019, in the first week after Labor Day, we saw $75 billion in issuance, and then 45 billion in the second week after Labor Day, so about 120 billion. It was only after that much supply that we saw some weakness in primary market demand. We saw new issue concessions jumped to about 12 basis points in order book coverage fall. And it was only after this amount of supply that we saw weakness in primary deal statistics.
                                                       But given how much more liquidity is in the market now than there was two years ago, we think even if we got that amount of issuance, 120 billion, it wouldn't be a problem at all for the market to absorb.

Dan Krieter:                                           That's a great point, and the one I was about to make is actually you sort of alluded to it, liquidity in September 2019 was arguably terrible, right? I mean, the SOFR spike was, what, September 20th or 22nd or something like that? Clearly there was a lot of collateral already in the financial system, so you'd think that maybe very heavy corporate supply would have a hard time finding a home. But I think you hit the nail on the head with what you're talking about.
                                                       The September supply wave is so well expected and so well communicated to the market that investors know to expect it and they have cash waiting for it. I mean, it's not a coincidence that if you look at the season... And we've talked about this before.
                                                       But if you looked at the seasonals in credit spread moves over various time horizons, looking at the last 10 years, looking pre-crisis, looking just post-crisis, the last 25 years as a whole, to try and eliminate the impact of outliers that obviously this type of analysis would be subject to, but looking over various time horizons, you consistently see that August is seasonally a very challenging month for credit spreads, and that September tends to be more supportive.
                                                       You tend to see widening in August as investors know that September supplier's coming potentially with some new issue concession or at least with some liquidity that isn't around in August, and they tend to avoid the market. And then when September gets here, they look to put money to work. It's been demonstrable in the past. 2019 is a great example. We expect to repeat this time around, particularly if supply actually comes in a little shorter than the record expectations that we think is being expected on the buy side.
                                                       I mean, I think that pretty much wraps it up on the IG side that we expect spreads to continue to perform. I'll just take a minute here and go in a little more detail on the SSA market as well, because I think we could see a bit of a divergence there. I mean, we have seen IG supply up until the most recent couple of weeks where supply has fallen off a cliff. We've seen IG supply be relatively heavy.
                                                       I mean, August as a whole is going to end with about 90 billion after about 75 plus billion in the first two weeks, which ends up being on the heavy side of projections, not significantly so, but still. The SSA market two months in a row now has fallen well shorter projections. August going into this week, there was a chance that SSA supply would be the lowest August we had on record. That ended up not being the case.
                                                       We've seen two deals now this week, one from IFC and one from CPPIB Capital, but still going to finish a second lightest August, and that's following the July where we had only about 15 plus billion in issuance and we were expecting closer to 25. We've seen two very, very light issuance months in a row here in the SSA market, and I think that that's going to potentially indicate heavier supply for September with some pent-up issuance needs.
                                                       Looking at SSA borrowers in aggregate, we see from a funding needs perspective that calendar year borrowers are in pretty good shape in the context of years past, but we have larger borrowing programs this year. There is still a borrowing need for calendar year issuers. And if we look at borrowers that are on a non-fiscal year cycle, March funders and June funders, we see that they are actually behind their progress in both 2020 and 2019 for this point in the year. There is reason to think that yes, to say borrows will be more active come September.
                                                       On the other hand, we have seen foreign currencies become a bit more attractive on a cross-currency basis compared to the US dollar in the past few weeks. For example, euro specifically, we're seeing threes and fives, marginally favor the Euro market for tier one SSA borrowers, which is a divergence from the pattern of most of this year, where obviously threes and fives would be on site for US dollars. But I will just say that the attraction from a cross-currency basis for those borrowers in euros is very, very slight.
                                                       You'd still expect to see borrowers maybe even sacrifice, what, one or two basis points to tap US dollar market. Just given the liquidity. Maybe one or two deals that would have come in US dollars go to euros instead. But I don't think it's going to be this massive exodus from the US dollar market. I still think we're going to see pretty heavy supply, particularly given the light July and August. High level, I'll just wrap it up here by saying we're looking for around 35 billion in supply, perhaps upwards of 35 billion in SSA supply this month.
                                                       That should lead to net positive supply of around five billion or so, depending on how you're looking at the metrics, which not huge, but it will be the heaviest month of net supply in the US dollar SSA market since April. I think the important point here is we've seen a divergence in supply in SSAs and IGs. We've seen very, very light SSA issuance in July and August and at least average supply in the IG market. And perhaps unsurprisingly, we've seen SSAs outperform IGs five plus basis points over that timeframe.
                                                       Well, now looking forward to the September supply, thinking that IGs will be taken down pretty well and SSAs getting at least a modest technical headwind combined with very, very narrow spreads, I think you could see some out-performance from lower rated credit. Heading into September, in addition to liking being overweight credit in general, I like being down the credit spectrum anticipating a reach for yield with rates very, very low. Some under performance perhaps in SSAs, things of that nature.

Dan Belton:                                            Yeah, Dan. Another reason I think that moving down the credit spectrum makes sense is we talked earlier in the podcast about how we think this Fed tapering timeline is kind of set. Into year end, there's not a ton of significant risks on the horizon that could lead to really severe credit spread decompression. I think that adds additional impetus to move into the triple B segment of the curve or even single A corporates.

Dan Krieter:                                           Yeah, that makes perfect sense to me, Dan. And actually this may dovetail nicely to just what we can talk about very briefly here before we wrap up the podcast for this week, and that was talking about the other sector that we talked about as being potentially a driver of credit in the next couple of months, and I think that's really the fiscal side of things. We talked about how the Fed is pretty much just on track with what we were all expecting going into it. But you look at what's on the plate for lawmakers in September, October, November, it's pretty significant.
                                                       We'll start with what we know has to be resolved in a couple months. That's the debt ceiling. Most projections for the X date are mid-November at the latest. And then you also have more talk of infrastructure spend stimulus that's going to be expiring, and we've seen some talk of federal lawmakers asking state governments to step up. And we've seen that.
                                                       Very high level, I don't want to get into anything super specific here, but there is certainly a recipe here for debt ceiling negotiations to be tied with the infrastructure package or a stimulus to at least some degree. And then you throw on top of that the complicating factor of the Delta variant and that we're seeing cases grow in the United States, particularly in the South, where this is actually following the same pattern of the last year.
                                                       Where in the summer, we see increases in COVID cases in the Southern states that are actually maybe more likely to be indoors during the summer where it's very, very hot. Stay inside in the air conditioning. In the more tempered climates up North, we're more outside more. And then as the fall gets here and into the winter, we see the people down South emerge from indoors. The COVID doesn't really spread so badly up there.
                                                       But now all the indoor people in the tempered climates, there's risk that COVID is going to spread more meaningfully in the Midwest and Northeast now heading into the winter. The concern here, just regardless of where it is, that COVID could continue to spread and does that give the government more political impetus to extend some stimulus here? I'm not really sure, but obviously there's a lot of moving parts here. Dan, how are you viewing the fiscal side of things heading into the fall?

Dan Belton:                                            I think in the base case, we're going to see a lot more fiscal support into the fall for the reasons you just mentioned. With respect to the debt ceiling specifically, I'm viewing November 1st as the market's expectation for the drop dead date. And like you said, I would expect to see that ceiling resolution linked to one or both of these bills in the next two months.

Dan Krieter:                                           And it's worth stating here, we're on record, our listeners will know that we've been talking about a return to historically low credit spreads in the next few months and actually pushing to new lows, in the mid-70s basis point handle there. But a key component of that view is that stimulus isn't going to fade as potentially projected right now. We're expecting there to be an extension similar... We've talked about the eviction moratorium in previous episodes, just that it's really difficult to take that stimulus back once it's given.
                                                       It's easier to do it, obviously, if things are "all better now," but if they're not. And as COVID will I don't want to say get worst, but it could continue to spread at a concerning rate and we could see some targeted shutdowns here and there, schools here, community centers there. Are we really going to see mortgage forbearance periods currently scheduled to end in October-November, are we really going to see those end? Are we really going to see people being evicted from their house potentially right before winter?
                                                       High level, I just think it's hard to take that stuff back. I think we're going to see an extension of stimulus, targeted stimulus like we saw at the eviction moratorium, more targeted, potentially done at the state level, what have you. But I just think we're going to have more stimulus coming. And that's really the driver that's going to get us to narrower spreads here is that we're going to see more stimulus.
                                                       Because if it's not more stimulus, spreads are quite tight already and we know that the Fed is going to be tapering asset purchases toward the end of the year, which we expect to influence spreads higher in the long-term. I mean, it's not going to be a taper tantrum or anything like we saw in 2013. But long-term as Treasury supply grows potentially as a result of tapering, we could see some crowding out impact. You've seen a lot of chatter of the end of asset purchases potentially being a bad thing for risk assets.
                                                       With that in mind, we might need some more stimulus to keep spreads narrowing into the end of the year. That is part of our view, but it's an important caveat worth making.

Dan Belton:                                            Yeah, Dan. I think you laid it out well. And just to put a bow on it, continued fiscal stimulus is likely going to keep spreads anchored. And given the worst thing, spread of the Delta variant, it's hard to see a lot of this stimulus starts to be taken back at least in the medium term. I'm targeting spreads heading their cyclical tights around year end or early next year, at least before the technical impact of Fed asset purchase tapering starts to really crowd out some private market borrowing and ultimately weigh on spreads later next year.

Dan Krieter:                                           Yeah, I don't disagree. Certainly there's a lot more to talk about here in the months ahead, but I thought it would be useful to at least provide a high level view for the next few months heading into the supply coming in September. You have anything else for today, Dan?

Dan Belton:                                            No, I think that covers it.

Dan Krieter:                                           Okay. Thanks for listening everybody and have a fantastic Labor Day. We will see you next week.

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

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