Insight – Page 14 – Cincinnati Asset Management

12 Oct 2022

High Yield Quarterly, Insight Rich Balestra - Portfolio Manager 0 comment

2022 Q3 High Yield Quarterly

In the third quarter of 2022, the Bloomberg US Corporate High Yield Index (“Index”) return was ‐0.65% bringing the year to date (“YTD”) return to ‐14.74%. The S&P 500 stock index return was ‐4.89% (including dividends reinvested) for Q3, and the YTD return stands at ‐23.88%.

The 10 year US Treasury rate (“10 year”) generally marched higher after a small dip in July as the rate finished at 3.83%, up 0.82% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) tightened 17 basis points moving from 569 basis points to 552 basis points. The higher quality segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 50 basis points, and B rated securities tightened 12 basis points. Meanwhile, CCC rated securities widened 61 basis points. The chart below from Bloomberg displays the spread moves in the Index over the past ten years with an average level of 430 basis points.

The Energy, Transportation, and Other Industrial sectors were the best performers during the quarter, posting returns of 1.28%, 1.20%, and 0.54%, respectively. On the other hand, Banking, Consumer Non‐Cyclical, and Brokerage were the worst performing sectors, posting returns of ‐3.91%, ‐2.82%, and ‐2.06%, respectively. At the industry level, aerospace and defense, refining, and gaming all posted the best returns. The aerospace and defense industry posted the highest return 3.49%. The lowest performing industries during the quarter were pharma, healthcare REIT, and retailers. The pharma industry posted the lowest return ‐9.57%. Crude oil has continued trending lower as can be seen on the chart at the left. OPEC+ members just met and agreed to cut oil production by two million barrels per day in a bid to help support the price of oil in the face of a weakening global economy. However, it is noted that the impact to supply is likely to be smaller than the headline number. “OPEC and its partners have been meeting online on a monthly basis and weren’t expected to arrange an inperson gathering until at least the end of this year. The slump in prices may have been what prompted the change of tack, requiring the first face‐to‐face talks since 2020.”ⁱ

The primary market remained very subdued during the third quarter. The weak market led to year‐to‐date issuance of $95.2 billion and $19.6 billion in the quarter. That is the lowest quarter of issuance in four years. Discretionary took 37% of the market share followed by Technology at a 28% share. Currently, there isn’t much concern for lack of capital access due to issuers being so proactive with refinancing in the past few years. In fact, only about $50 billion in high yield bonds are due to mature from now through the end of 2023.

After the Federal Reserve lifted the Target Rate by 0.75% at their June meeting, Fed Chair Jerome Powell acknowledged that the hike was “an unusually large one.” It may have been a large one, but apparently it was not enough as the Fed raised an additional 0.75% at both the July and September meetings. For those keeping score, that brings the Fed to 300 basis points of raises this year.

The dot plot chart shows how the Fed projections of the 2022 year‐end Target Rate have evolved over the past year. The Fed was clearly behind the curve and now believes stuffing the market with three consecutive “unusually large” hikes in a singular bid to break inflation is the appropriate move, notwithstanding all the other consequences. “We have always understood that restoring price stability while achieving a relatively modest increase in unemployment and a soft landing would be very challenging,” Powell said. “We have got to get
inflation behind us. I wish there were a painless way to do that. There isn’t.”ⁱⁱ Based on the Fed’s Summary of Economic Projections, they accept that the continuing rate hikes are going to lower growth and push up unemployment.

Intermediate Treasuries increased 82 basis points over the quarter, as the 10‐year Treasury yield was at 3.01% on June 30th, and 3.83% at the end of the third quarter. The 5‐year Treasury increased 105 basis points over the quarter, moving from 3.04% on June 30th, to 4.09% at the end of the third quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. The revised second quarter GDP print was ‐0.6% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 1.6% with inflation expectations around 8.0%.ⁱⁱⁱ

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. Additionally, our interest rate agnostic philosophy keeps us generally positioned in the five to ten year maturity timeframe. Due to the continued rate moves, this positioning was a detractor of performance in the quarter as short‐end maturities outperformed. Further, our credit selections within communications and energy were a drag on performance. Benefiting our performance was our lack of exposure to pharma and our credit selections within healthcare. All totaled, the CAM High Yield Composite Q3 net of fees total return of ‐1.38% underperformed the Index. The Composite YTD net of fees total return of ‐17.06% also underperformed the Index.

The Bloomberg US Corporate High Yield Index ended the third quarter with a yield of 9.68%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 25 over the quarter moving from a low of 20 in mid‐August to a high of 32 atthe end of September. For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The third quarter had two bond issuers default on their debt. The trailing twelve month default rate stands at 0.83%.iv The current default rate is relative to the 0.92%, 0.27%, 0.23%, 0.86% default rates from the previous four quarter end data points listed oldest to most recent. The fundamentals of high yield companies still look good considering the economic backdrop. From a technical view, fund flows were positive in July but negative in August and September. The 2022 year-to‐date outflow stands at $61.5 billion.^v Without question there has been a fair amount of damage in bond markets so far this year. It is important to remember that bonds are a contractual agreement with a defined maturity date. Thus, despite price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are quite low and fundamentals are still providing a cushion. No doubt there are risks, but
we are of the belief that for clients that have an investment horizon over a complete market cycle, high yield deserves to be considered as part of the portfolio allocation.

As we move into the last quarter of 2022, fixed income markets remain pressured as the Fed continues raising the Target Rate. The US dollar has been moving higher all year. Over 80% of central banks around the world are now hiking, the highest percentage on record.vi Japan has taken to currency intervention. The Bank of England is hiking while the British government is pushing through their largest tax cut package since 1972. Citi’s London team commented that euro credit markets are disorderly. Subsequently, the Bank of England started buying gilts while some of the tax cut package was walked back. Back in the US with the message from the Fed steadfast, caution is warranted as uncertainty remains around the cycle’s terminal rate and the resulting depth of an intentional economic slowdown. Markets have been roughed up this year, but brighter days will eventually appear. As this cycle plays out, current uncertainty and volatility can create opportunities that lead back to positive returns. Our exercise of discipline and selectivity in credit selections is important as we continue to evaluate that the given compensation for the perceived level of risk remains appropriate. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

i Bloomberg October 4, 2022: OPEC+ Considers Output Limit Cut
ii Bloomberg September 22, 2022: Powell Signals Recession May Be the Price for Crushing Inflation
iii Bloomberg October 3, 2022: Economic Forecasts (ECFC)
iv JP Morgan October 3, 2022: “Default Monitor”
v Wells Fargo September 29, 2022: “Credit Flows”
vi Goldman Global Markets Insights September 23, 2022: Markets/Macro

12 Oct 2022

Insight, Investment Grade Quarterly Josh Adams - Portfolio Manager 0 comment

2022 Q3 Investment Grade Quarterly

Negative performance continued to plague the investment grade credit market during the third quarter and 2022 built on its record as the most difficult year of performance that the market has ever experienced. It was a hopeful start to the quarter, as investment grade bonds posted sharply positive returns for the month of July, but August and September were ugly, as Treasury yields climbed higher, creating a major headwind for performance. Credit spreads finished the quarter modestly wider but behaved reasonably well for most of the period and the spread performance of IG‐credit was relatively strong compared to other risk assets, but the magnitude of the sell‐off in Treasuries during the quarter and during the first 9 months of 2022 has led to historically poor performance across fixed income. The option adjusted spread (OAS) on the Bloomberg US Corporate Bond Index widened by 4 basis points during the quarter to 159 after having opened the quarter at an OAS of 155. The 10yr Treasury opened the quarter at 3.01% and finished 82 basis points higher, at 3.83%. The 5yr Treasury opened the quarter at 3.04% and finished 105 basis points higher, at 4.09%. The 2yr Treasury opened the quarter at 2.95% and finished 133 basis points higher, at 4.28%. The very front end of the yield curve has experienced the most dramatic movement year‐to‐date and the 2yr has now climbed 355 basis points during 2022 through the end of the third quarter.

The Corporate Index posted a third quarter total return of –5.06%. CAM’s Investment Grade portfolio net of fees total return for the third quarter was –4.12%.

The drawdown in credit has continued. We cannot predict when the tide will turn but we are confident that it will do so eventually, and it is only a matter of time. An increasing amount of hawkishness has been priced into the Treasury markets as the year has worn on. Eventually, the economic data on inflation will break, whether it is this year, in 2023, or even beyond that. The valuations and compensation afforded from high quality investment grade credit are as high as they have been in a very long time. The process of getting to these yields has been painful to endure but the market is now trading at levels that set up well for investors with longer time horizons. The market could cheapen further but higher Treasury rates and wider credit spreads have given investors a larger margin of safety and increased the likelihood of positive returns in the future.

Cash Alternatives Are Back, Finally

We are a bond manager and are not in the business of giving investment advice, but this is a topic that has started to come up frequently in our conversations so we thought it would be helpful to discuss. The rise in short term Treasury rates has given investors the option to generate higher levels of income without taking much duration risk for the first time in a long time. For example, the 2-year Treasury has not offered yields this high since 2007. This is a great cash alternative for many investors in our opinion. Some may prefer to park their short term funds while for others it may make sense to allocate a larger portion of their portfolio.

We have received questions asking why we have not changed our intermediate investment grade strategy, putting all of our investments into short duration assets or even short term Treasuries. What investors need to understand is that a portfolio that is entirely reliant on short duration securities introduces a risk for those that have medium or longer term time horizons: reinvestment risk. When the time comes to sell or, for example, when the 2-year Treasury matures, the landscape could look totally different. Credit spreads could have raced tighter or intermediate Treasury yields could have decreased – or both of these things could have occurred, meaning the investor missed out on larger returns and now they find themselves in a position where they need to redeploy capital into a market with richer valuations. So we would caution investors from making wholesale tactical changes to their fixed income portfolios. A Strategic approach may yield better results, because like all risk assets, fixed income benefits an overall portfolio by being diverse in its exposure. Having different maturities, credit exposures and asset classes within fixed income is in our opinion the best way to build a portfolio with a longer term view. We do offer a variety of short duration strategies at CAM, but for most investors with longer time horizons a combination of short and intermediate duration strategies will typically be the best fit.

What Now for Low Dollar Bonds?

We have officially exited the longstanding regime of ultralow interest rates. As rates have rapidly increased, some of our holdings have incurred significant price declines. This is particularly the case with bonds that we purchased in 2020-2021 that were newly issued at the time. This was a time period when interest rates were much lower and credit spreads were tighter than they are today. As a result, many of these bonds have coupons that are lower than Treasuries are today, thus they have seen significant price declines, with dollar prices in the high 70s or low 80s (price declines of more than 15-20% since issuance). In almost all of these cases, our ongoing analysis has shown that the company that issued the bonds is operating well from the standpoint of creditworthiness. In other words, the price declines have not stemmed from concerns over credit risk but rather the declines have been all about duration and higher interest rates. We have received questions from investors about our expectation for price recoveries in these bonds.

Ultimately, the prices of these bonds stand to benefit the most from the passage of time and a reversal of the currently inverted yield curve. There are two curves that we deal with as a bond manager: the corporate credit curve and the Treasury curve. The corporate credit curve represents the extra spread that an investor receives for purchasing a corporate bond instead of a Treasury –it is the spread on top of the underlying Treasury. The corporate credit curve remains steep at the moment, as it almost always is. For A-rated credit at the end of the third quarter it was not uncommon for us to observe a 5/10 curve of 50 basis points for many A-rated credits. That is, you could sell a 5yr bond of a company at a spread of 50 basis points over the 5yr Treasury and then use those proceeds to buy the 10 year bond of the same company at a spread of 100 basis points over the 10yr Treasury. The corporate credit curve is even steeper for BAA-rated credits because riskier credits require steeper curves as investors demand more compensation to own the bonds of a lower quality credit. The problem with doing an extension trade at the moment is that at the end of the quarter the 5/10 Treasury curve was inverted to the tune of -26 basis points, which takes a big bite out of the compensation afforded by an extension trade because we are selling off of a higher 5-year Treasury (4.09%) and purchasing a bond that trades off a lower 10-year Treasury (3.83%). We would still be increasing yield by doing this trade, because of the steepness of the corporate credit curve, it is just much less of a yield increase than we would get in a typical environment where we have an upward sloping Treasury curve and an upward sloping credit curve. Thus, in order for these deeply discounted bonds to recover value it requires Treasury yield curve normalization. Historically, yield curve inversions have been brief in nature. The longest period of inversion was 21 months, beginning August 1978 until April 1980 . We don’t know when the yield curve will normalize but we expect that it will over time.

The best prospect for value recovery in a deeply discounted bond that still has good credit metrics is to trust the bond math and to embrace the passage of time as our friend. With each passing day, a bond gets shorter and closer to its maturity and the credit spread gets tighter, all else being equal. The passage of time will also allow the Treasury curve to normalize and give investors a chance to recover principal and to execute more favorable extension trades where both the value of selling and buying are maximized. Finally, as the bond is held, the investor receives coupon payments which serve to help offset the decline in price.

How Are We Responding?

We will always stay true to our mandate as a manager of intermediate maturities, but we will also adapt to market conditions and we have responded to 2022’s market volatility in a number of ways. The single biggest dislocation we have observed in our portion of the market is that bonds that mature in 7.5-8.5 years have consistently offered exceptional value relative to other portions of the yield curve. We are still buying 9-10 year maturities when it makes sense to do so but we have been able to consistently find value in shorter maturities which has allowed us to take less duration risk while increasing yield. For example, it has become commonplace for the ~8yr bond of a company to trade at a wider spread than the ~10yr bond of the same company, which is something that should not happen with a high degree of frequency. This type of dislocation is something that has always occasionally occurred in the market but it is typically idiosyncratic in nature and quickly arbitraged away by market participants. What we are observing in 2022 is that this has become widespread which has presented an opportunity for an investor like us because when we buy an 8-year maturity we have a 3 to 4 year time horizon before we are looking to sell. 10-year bonds are trading rich to 8-year bonds usually because of some type of market technical. We believe that it is most likely occurring because the 10-year bond is being bid-up by short term investors that are primarily concerned with short term liquidity. These investors believe that the 10-year bond is more liquid and could be easier to sell a week or a month from now if needed. We are longer term investors and we are not concerned about liquidity a week or a month from now, we care more about liquidity 3 or 4 years from now. When our 8-year bond rolls down the yield curve and becomes a 5-year bond we are highly confident that we will have plenty of liquidity when the time comes to sell our bonds. Thus we will happily take advantage of this dislocation for our client accounts.

Not only have we been able to buy shorter maturities, but we have also become more patient when evaluating the sale of existing holdings. Much of this patience is borne out of necessity as a result of the currently inverted yield curve but some of it is also related to fund flows and technical factors at play in the market. Traditionally, we would look to exit most securities right around the time that they have 5 years left to maturity. For extremely high quality A-rated paper you could see us sell with 5.5 years left to maturity while some lower quality BAA-rated paper may need to roll down to 4-4.5 years in order to maximize value. What we are seeing in the current environment is that there is simply too much “juice” left in many of our 5 year holdings so we are continuing to hold them beyond the typical 5-year time period. We are willing to wait; allowing that bond to roll down to 3 or 4 years to maturity–it is entirely about being opportunistic and maximizing value for our investors. As the Treasury yield curve normalizes, we would expect that the market will revert to an environment where it makes more sense to sell nearer the 5-year mark.

We have also been able to take even less credit risk than we typically would. To be clear, we already position our investment grade strategy as “up-in-quality” relative to its benchmark and that high quality bias comes from the fact that we cap our BAA-rated exposure at 30% while the Corporate Index was 48.93% BAA-rated at the end of the 3^rd quarter. Even though we have a meaningful underweight in BAA-rated credit, we maintain a focus of adding value for our investors through credit research and identification of those BAA-rated credits that are mispriced or that are poised to improve their credit metrics. Traditionally, we have not necessarily shied away from risk taking in lower quality credit so long as it was for the right reasons and that the compensation was appropriate for the risk incurred. We always intend to stick to our cap of a 30% weighting for this portion of the market but we have always been willing to take credit risk based on thorough research. What we are finding in the current environment, however, is that we simply do not need to take much risk in order to find compelling value. There are plenty of very solid BAA-rated credits that offer spreads that are quite attractive in our view. We are positioning the portfolio for a recessionary period and shying away from those credits that are most exposed and we are in a position where we are able to dial-back risk without giving up yield.

Fed Fait Accompli

The Federal Reserve has been active in 2022, to say the least. Six rate hikes in six months is unprecedented, and the market has never experienced so many hikes in such a short period of time. The Fed has been clear in its communication in recent weeks. It is fully committed and will not stop until inflation shows signs of slowing. Our only prediction about where the Fed goes from here is that we continue to expect tightening through further increases in Fed Funds until the data on inflation and labor shows signs of cooling. This data is entirely backward looking in nature. This could be problematic for the economy because rate hikes take time to work their way through the economy. With the Fed focused on backward looking data, it introduces a risk that financial conditions will tighten too much and the potential for overtightening diminishes the probability of a soft landing. At the very least, it appears likely that the economy will slow throughout 2023. Growth may even turn negative, thrusting the economy into recession. If there is any good news that investors can take from the Fed’s quick action to this point is that we are likely closer to the end of tightening conditions than we were just a short six months ago.

Slipping Into Darkness

The economy is still reasonably strong by many measures but cracks are starting to form in the foundation, and housing could be leading the way. Housing is an important sector for the economy and it makes up 15-18% of GDP on average. Recently released data showed that during July housing prices experienced their first monthly decline since January 2019. It should come as no surprise that housing has shown signs of slowing as mortgage rates have climbed throughout 2022 and this his had a severe impact on home affordability. According to the US NAR Homebuyer Affordabilty Index, the monthly payment on a median priced single family home ($410,600) went from $1,011 in January of 2021 to $1,933 at the end of June 2022. Mortage rates were up another 1% from June through September so this payment will be even higher when the August and September data is released, with the montly payment on a median home having more than doubled in less than two years. Builders have started to report increasing cancellations and inventory has risen . It is only a matter of time until this data starts to filter through to lower home prices and ultimately to lower GDP.

We have also begun to see earnings revisions in other cyclically sensitive portions of the economy with companies in the chemical and semiconductor industries pointing to slowing demand, especially out of Europe. Retailers like Nike have reported bloated inventories and aggressive promotions. Large stalwart companies like Walmart and Amazon are slowing or altogether pausing hiring. It is too early to tell for sure but the negative data points are piling up, and we do not view these as the signs of a soft landing. We do not necessarily believe a severe recession is the base case but it is becoming more likely that the economy will slip into a recession at some point in 2023 or 2024.

What’s Ahead for Credit?

The good news is that the vast majority of the investment grade universe has balance sheets that will hold up reasonably well in a scenario where the economy experiences a modest recession. Investment grade companies were busy in 2020 and 2021, issuing debt at record low interest rates, decreasing their interest expense burdens and pushing out maturity walls. Most companies do not need to issue new debt to fund capital budgeting projects or to refinance existing debt balances. Cash balances have declined from their 2021 peak but remain elevated by historical standards. Interest coverage ratios are near a 13-year high. We are seeing some deterioration: revenue and earnings are slowing and for some companies profit margins are deteriorating, but these are coming off of very high levels. Many investment grade companies have multiple levers to pull in the face of a slowing economy and they have shown a willingness to make conservative choices with regard to capital budgeting and share buybacks. Credit fundamentals remain strong and point to our aforementioned narrative that the selloff in credit during 2022 has been much more about interest rates than it has been about creditworthiness.

As far as spreads are concerned, the OAS on the index recently hit a year-to-date wide of 164 on September 29. If there is a modest recession then spreads could trade out to 200 and they could temporarily trade even wider in a severe recession or in the event that we get an exogenous shock to the markets but investors are being reasonably well compensated from a yield perspective. The yield on the Corporate Bond Index finished the quarter at 5.69%, which provides some cushion against the potential for wider spreads.

Keep on Trucking

The volatility in the market has presented a real opportunity for investors. Yields have risen and investors do not need to be nearly as creative in their quest to generate income. Investment grade credit is a straightforward, easily understood, asset class. Due diligence and credit research are required to identify the companies that have the best creditworthiness and from there a manager can determine opportunities in the market based on their own measure of risk and reward. We are no longer in an environment of ultralow interest rates and tight credit spreads where investors may feel compelled to consider increasingly complex asset classes or products in order to generate income. Investment grade companies, by and large, will not have difficulty navigating a recessionary environment. Spreads could go wider and Treasury yields could even retest the high end of their range but the market has cheapened so much in such a short period of time that it is hard to ignore the level of compensation that is offered by the asset class. We think that investors that stay the course will be rewarded over a longer time horizon.

We thank you for your business and your continued interest. We look forward to hearing from you to discuss the credit markets and to help with any questions you may have.

i St. Louis Fed, 2022, “10‐Year Treasury Constant Maturity Minus 2‐Year Treasury Constant Maturity”
ii National Association of Homebuilders, 2022, “Housing’s Contribution to Gross Domestic Product” https://www.nahb.org/newsand‐
economics/housing‐economics/housings‐economic‐impact/housings‐contribution‐to‐gross‐domestic‐product
iii The Wall Street Journal, September 27 2022, “Home Pries Suffer First Monthly Decline in Years”
iv Bloomberg, August 9 2022, “Builders Are Stuck With Too Many Houses as US Buyers Pull Back”
v The Wall Street Journal, September 29 2022, “Micron Issues Another Muted Outlook After Missing Expected Sales Results”
vi Barron’s, September 16 2022, “Huntsman Falls Sharply After Cutting Profit Forecast”
vii Charged Retail Tech News, October 4 2022, “Nike is Aggressively Offloading Inventory Before the Holiday Season”
viii The Wall Street Journal, September 22 2022, “Walmart to Slow Holiday Hiring”
ix The New York Times, October 4 2022, “Amazon Freezes Corporate Hiring in Its Retail Business”
x J.P. Morgan North America Corporate Research , September 8, 2022, “HG Credit Fundamentals: 2Q 2022 Review”

07 Oct 2022

High Yield Weekly, Insight, Uncategorized Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.8 billion and year to date flows stand at -$60.7 billion. New issuance for the week was nil and year to date issuance is at $88.3 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds were headed for a weekly gain heading into the jobs report on Friday morning, as yields moved to 9.13% from 9.88%, the highest since April 2020.
The gains came amid weak US manufacturing data and a 14-month low in US job openings.
The junk-bond rally followed a broad risk-on move as equities rebounded from the worst monthly loss in more than two years in September.
Still, the gains may be short-lived as Fed officials warn that market expectations for a pivot are misplaced and that there’s a need to boost rates to “restrictive territory.”
Continuing macro uncertainty, rising oil prices and steadily rising yields have turned issuers away from the primary market.
The sudden rally in junk bonds after the September losses brought investors back to the asset class with a cash inflow of just under $1b this week.

(Bloomberg) US Jobs Rise While Unemployment Drops, Keeping Pressure on Fed

U.S. employers continued to hire at a solid pace last month and the jobless rate unexpectedly returned to a historic low, indicating a sturdy labor market that puts the inflation-focused Federal Reserve on course for another outsize interest-rate hike.
Nonfarm payrolls increased 263,000 in September after a 315,000 gain in August, a Labor Department report showed Friday. The unemployment rate unexpectedly dropped to 3.5%, matching a five-decade low. Average hourly earnings rose firmly.
The median estimates in a Bloomberg survey of economists called for a 255,000 advance in payrolls and for the unemployment rate to hold at 3.7%. Hiring was relatively broad based, led by gains in leisure and hospitality and health care.
The figures are the latest illustration of the perennial strength of the US job market. While there have been some indications of moderating labor demand — most notably a recent decline in job openings and an uptick in layoffs in some sectors — employers, many still short-staffed, continue to hire at a solid pace. That strength is not only underpinning consumer spending but also fueling wage growth as businesses compete for a limited pool of workers.
The Fed, meanwhile, is hoping to see a significant softening in labor market conditions, with the goal of cooling wage growth and ultimately inflation. While the payrolls advance was the smallest since April 2021, policy makers are watching to see if their rate hikes spur an increase in the unemployment rate.
This is the last jobs report Fed officials will have in hand before their November policy meeting as they consider a fourth-straight 75-basis point interest-rate hike. Fresh inflation data out next week will also play a fundamental role in their decision making. The report is projected to show the depth and breadth of the Fed’s inflation problem, with a key gauge of consumer prices potentially worsening.
The labor force participation rate — the share of the population that is working or looking for work — eased to 62.3%. Among those ages 25 to 54, it also dipped.
The jobs report showed average hourly earnings were up 0.3% from August and up 5% from a year earlier, a slight deceleration from the prior month but still historically elevated. The solid increase suggests the Fed will have to continue to raise interest rates as it aims to rein in rapid wage growth that has bolstered household spending.
Central bank officials have been clear recently about their commitment to taming inflation, even if that leads to higher unemployment and recession, because they say that failing to do so would be worse for Americans. Fed Chair Jerome Powell said last month that slower growth and a softer labor market are painful for the public, but that there isn’t a “painless” way to get inflation down.

16 Sep 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.1 billion and year to date flows stand at -$54.8 billion. New issuance for the week was $3.0 billion and year to date issuance is at $82.3 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are headed for a weekly loss to end the August rebound after a higher-than-expected inflation reading on Tuesday triggered a broad market selloff. Yields surged to a two-month high of 8.61% after steadily rising for three straight sessions, pushing the week-to-date loss to 1.5%.
The losses extended across ratings in the U.S. high yield market, with CCCs leading the pack with the worst week-to- date loss of 1.7%, after sliding for three consecutive sessions. Yields rose to a two-week high of 13.72% and spreads were approaching distressed levels.
The primary market was suddenly jolted after the CPI data earlier in the week fueled concerns that the Federal Reserve may need to raise benchmark interest rate by even 100bps to tame inflation and trigger a recession.
The primary market may pause after the Citrix debt sale was used to assess the risk appetite and clearing price levels for new debt amid rising rates and slowing economy. Nielsen Holdings and Tenneco are among the other leveraged buyouts in the queue to sell debt at some point.

(Bloomberg) Inflation Surprise Puts Onus on Fed to Hit Brakes Even Harder

The U.S. economy has shown surprising resilience in the face of the fastest inflation and interest-rate hikes in a generation. That means the Federal Reserve will have to stomp even harder on demand.
What started as a pandemic-driven supply shock has morphed into widespread inflation rooted just as much in resilient demand, underscored by unexpectedly high numbers that dashed hopes price gains were ebbing. While consumers are showing some signs of slowing, they’re still largely keeping up with persistent price pressures, powered by historic wage gains.
All told, the Fed has a much harder task on its hands than previously thought. If Americans won’t dial back spending further, odds favor the central bank becoming that much more aggressive to take more wind out of the economy’s sails with the goal of bringing inflation down.
“It tells you that it’s going to take a longer time, and will require higher rates — and in macro language, maybe even require more demand destruction,” as in higher unemployment and slower growth, said Torsten Slok, chief economist at Apollo Management. “It raises the probability of a recession.”
Consumer prices advanced by more than forecast in August, defying expectations for a monthly drop due to falling gasoline prices. Shelter, food and medical care were among the largest contributors to price growth, underscoring the breadth and severity of inflation with several categories posting record increases.
“My experience with inflation is that some of the components that were very strong in today’s report, they tend to be sticky and have a lot of inertia,” like rent, said Blerina Uruci, U.S. economist at T. Rowe Price Associates. “So I would expect those to remain pretty strong in the coming months.”
The Atlanta Fed’s so-called sticky CPI measure rose 6.1% in August from a year ago, the biggest gain in 40 years. Meantime, the Cleveland Fed’s median CPI, which excludes categories with the largest price changes, increased by the most in data back to 1983.
Excluding the volatile food and energy categories, the so-called core CPI climbed 0.6% from July, double the median estimate in a Bloomberg survey of economists. The core measure rose 6.3% from a year ago, the first acceleration in six months and near a four-decade high, the Labor Department’s report showed.
“The composition is even more troubling than the aggregate reading,” Stephen Stanley, chief economist at Amherst Pierpont Securities, said in a note. “Outside of falling gasoline prices, inflation appears to be just as hot as ever, which means that the Fed still has plenty of work to do.”
It also means that the Biden administration and fellow Democrats have plenty of work to do, as the latest data may threaten what had been growing optimism in the party that they would hold their congressional majorities in November.
Traders are now fully expecting the central bank to raise interest rates by another 75 basis points when policy makers meet next week, which would be the third-straight hike of that size. They’re also upping bets that officials will go bigger at their November gathering and see the tightening cycle peaking around 4.3% early next year — more than a quarter-point higher than what was projected before the CPI report.
Chair Jerome Powell has communicated a stronger resolve to stamp out inflation since the Fed’s summit in Jackson Hole last month, signaling that the central bank is likely to keep raising interest rates and leave them elevated for a while. He’s stuck to that hawkish view and several of his colleagues also support hiking rates to a point that more clearly restricts demand.

16 Sep 2022

Insight, Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Investment grade credit spreads were unchanged for most of the week but the market has been drifting wider Friday morning so the index may finish 1-2 basis points wider by the time the sun has set on the week. IG credit led the way this week having substantially outperformed other risk assets on a spread basis. The Bloomberg US Corporate Bond Index closed at 141 on Thursday September 15 after having closed the week prior at 141. The 10yr Treasury closed last week at 3.31% and is trading at 3.43% as we go to print on Friday morning. Through Thursday the Corporate Index had a negative YTD total return of -15.58% while the YTD S&P500 Index return was -17.2% and the Nasdaq Composite Index return was -26.98%.

The big economic news of the week was the CPI print on Tuesday morning which showed that prices increased slightly in August versus market expectations for a slight decrease. This was a disappointing number for risk assets and stocks immediately reacted by trading much lower and Treasuries of all maturities sold off sharply. This report showed that the Fed still has much work to do before inflation cools to a level nearer its 2% target. CPI data has assured a 75bp hike at the FOMC meeting next week and has even brought forth the possibility of a surprise 100bp hike. Thursday morning brought with it the second big economic data point of the week with mixed retail sales numbers that showed a stronger than expected increase for August but a revision downward for July. The broad picture painted by the last couple retails sales reports has showed that consumer spending has been slowing for durable goods but has remained relatively strong for services. The Fed will be on the tape next week with its rate decision on Wednesday.

This was a volatile week with equities trading lower and Treasuries selling off, both of which served to impugn supply estimates with $18.7bln of new debt priced relative to estimates of $35-40bln. Next week the street is looking for about $15bln of issuance with Wednesday off limits for issuers due to the FOMC. Once again we find ourselves in more of a day-to-day type of environment for the new issue calendar.

Fund flows held up remarkably well this week considering the soft sentiment for risk assets. Per data compiled by Wells Fargo, outflows for the week of September 8–14 were -$0.4bln which brings the year-to-date total to -$111.6bln. This was the third consecutive week of modest outflows and the pace of outflows has decelerated each of the past three weeks.

09 Sep 2022

Insight, Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Investment grade credit spreads were pushed wider to start the week after a deluge of new issue supply on Tuesday. By mid-Wednesday morning spreads were trending tighter after investors had a chance to digest issuance and now this Friday morning it is clear that the market is set to finish the week better than last which sets up well for another bout of new issue on Monday. The Bloomberg US Corporate Bond Index closed at 143 on Thursday September 8 after having closed the week prior at 145. The 10yr Treasury closed last week at 3.19% and is trading at 3.27% as we go to print on Friday morning. Through Thursday the Corporate Index had a negative YTD total return of -15.02% while the YTD S&P500 Index return was -15.12% and the Nasdaq Composite Index return was -23.74%.

The FOMC does not meet until September 21 but next Tuesday will see the release of the latest CPI figure which is a big data point that will guide the Fed in its choice of a 50bp or 75bp hike 12 days from now. Other central banks joined the rate-hike party this week. On Wednesday, the Bank of Canada increased its target for the overnight rate by 75bps to 3.25%, a 14-year high for that country. The European Central Bank followed suit on Thursday by increasing its deposit rate from 0% to 0.75%. The ECB also slashed its forecast of economic growth in 2023 to a mere 0.9%. Critics believe this growth target is overly optimistic and that the European economy will find itself in recession sooner rather than later and we at CAM agree with that view.

The holiday shortened week saw 31 companies sell over $51bln of new debt. The street is looking for $35-40bln of issuance next week and with CPI at 8:30am on Tuesday we would expect a tidal wave of issuance on Monday if the market tone is receptive as companies look to get ahead of that economic print. Issuance right now is very much day-to-day depending on the market’s appetite for risk on any given day as well as being highly dependent on the increasingly volatile Treasury market.

Per data compiled by Wells Fargo, outflows moderated this week of September 1–7 to -$0.9bln which brings the year-to-date total to -$111.2bln. This was the second consecutive week of modest outflows on the back of a 5 week streak of inflows for the asset class.

26 Aug 2022

Insight, Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Investment grade credit spreads drifted wider in the first half of the week and then traded tighter amid low volume into Friday morning. After Fed Chair Jerome Powell spoke on Friday the street tried to take spreads wider but trading volume has remained low with the market in its end-of-summer seasonal slow-down. The Bloomberg US Corporate Bond Index closed at 134 on Thursday August 25 after having closed the week prior at 136. After the dust settles the index is likely to finish the week unchanged or close to it. The 10yr Treasury closed last week at 2.97% and is trading at 3.05% as we go to print on Friday morning. Through Thursday the Corporate Index had a negative YTD total return of -13.1% while the YTD S&P500 Index return was -11% and the Nasdaq Composite Index return was -18.78%.

Economic data this week was light relative to the last two weeks and much of the week was spent with investors anticipating Powell’s Friday morning speech. The speech was less than 10 minutes in length, but that was all the market needed to understand that the Fed is committed to using restrictive policy to reduce inflation even if it causes some pain for households and businesses. Chair Powell said 75bps is still on the table for the Fed’s September 21 FOMC rate decision.

There was no new issuance this week. It wouldn’t have been surprising if there would have been a deal or two on Monday or Tuesday but Monday was a volatile day for stocks and risk assets in general so issuers decided to pack it in for the week, and probably for the summer. We anticipate no issuance again next week before things start to pick up again after Labor Day. September is expected to see a high volume of issuance.

Investment grade credit reported a fifth straight week of inflows. Per data compiled by Wells Fargo, inflows for the week of August 18–24 were +$2.8bln which brings the year-to-date total to -$108.9bln.

26 Aug 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$4.1 billion and year to date flows stand at -$48.3 billion. New issuance for the week was $0.4 billion and year to date issuance is at $79.3 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds head toward a loss for the second consecutive week as investors pull $4.1 billion from US junk bonds for the second-biggest such withdrawal of the year on renewed concerns about recession.
Yields surged and spreads widened across ratings for the second consecutive week, ending a rally that began in July and extended to the first two weeks of August.
Junk bond yields rose 20bps this week to near 8%. Spreads widened 14bps to +446.
BBs, the most rate-sensitive in the junk bond market, are moving toward a big loss in August, with month-to-date losses at 1.15% for the worst performing asset in the US high-yield market.
BBs are on track to end with losses for the second straight week.
CCC spreads have steadily climbed back to distressed levels widening 52bps week-to-date to +975. The index is also expected to end the week in red, with week-to-date losses at 0.78%.

(Bloomberg) Powell Says History Warns Against Prematurely Loosening Policy

Federal Reserve Chair Jerome Powell signaled the US central bank is likely to keep raising interest rates and leave them elevated for a while to stamp out inflation, and he pushed back against any idea that the Fed would soon reverse course.
“Restoring price stability will likely require maintaining a restrictive policy stance for some time,” Powell said Friday in remarks prepared for the Kansas City Fed’s annual policy forum in Jackson Hole, Wyoming. “The historical record cautions strongly against prematurely loosening policy.”
He said restoring inflation to the 2% target is the central bank’s “overarching focus right now” even though consumers and businesses will feel economic pain. He reiterated that another “unusually large” increase in the benchmark lending rate could be appropriate when officials gather next month, though he stopped short of committing to one.
“Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook,” he said.
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance,” Powell said.
Other Fed speakers in recent days have also pushed back against expectations, priced into futures markets, that the Fed would raise rapidly to a restrictive policy stance and then begin to ease.
Restoring price stability will require a “sustained” period of below-trend growth and a weaker labor market, Powell said. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said.
Inflation according to the Fed’s preferred measure rose 6.3% for the 12-month period ending July, according to a government report released earlier on Friday , while the core measure minus food and energy rose 4.6%.
“While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the committee will need to see before we are confident that inflation is moving down,” the Fed chief told the audience.
“We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%.”
Fed officials in June projected rates rising to 3.4% by the end of this year, according to their median estimate, and 3.8% by end 2023. They will update those forecasts in September.

19 Aug 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.1 billion and year to date flows stand at -$44.1 billion. New issuance for the week was $4.7 billion and year to date issuance is at $78.9 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are on track to end the six-week gaining streak after steadily falling for three consecutive sessions, with a week-to-date loss of 0.67%. Yields jump 16bps week-to-date to 7.59%, rising for the first time in seven weeks and the biggest weekly leap since early July after Federal Reserve minutes noted risks from the central bank tightening more than necessary. The losses stretched across the high yield market, with CCCs headed toward its first weekly loss, falling by a modest 0.29% and snapping the four-week rally. The losses followed a three-day decline, the longest losing streak in five weeks.
CCC yields are headed toward the biggest weekly surge since July 1, rising 28bps week-to-date to 12.51%.
Junk bond losses accelerated after mixed signals from different FOMC voting members, causing uncertainty over the extent of rate hikes in the coming months and its impact on growth.
The primary market saw some borrowers rush in a hurry to take advantage of the risk-on move ahead of Jackson Hole symposium next week where the Fed could reiterate that it was focused on taming inflation and the fight against inflation continues.
The issuance volume this week totals almost $5b, the busiest since early June.
The month-to-date supply tally was at a modest $8b, the slowest August since 2014.
The junk bond market may extend the decline on Friday amid a broader risk-off move. U.S. equity futures sank with Treasuries after a chorus of Federal Reserve officials reiterated their resolve to continue rate hikes and traders raised tightening wagers for other major central banks.

(Bloomberg) Fed Officials Offer Mixed Signals on Size of September Rate Hike

U.S. central bankers offered divergent signals over the size of the next interest-rate hike, with St. Louis’s James Bullard urging another 75 basis-point move while Kansas City’s Esther George struck a more cautious tone.
Bullard, who is one of the most hawkish policy makers at the U.S. central bank, told the Wall Street Journal in an interview published Thursday that he favored going big again, arguing “we should continue to move expeditiously to a level of the policy rate that will put significant downward pressure on inflation.”
“I don’t really see why you want to drag out interest rate increases into next year,” he said.
The Fed in July raised the target range for its benchmark rate by three-quarters of a percentage point to 2.25% to 2.5%, following a similar-sized hike in June to cool the hottest inflation in 40 years. Officials have since signaled that either 50, or another 75 basis points, were on the table for their Sept. 20-21 meeting, depending on the data. They get fresh monthly readings on inflation and employment between now and then.
Both Bullard and George are voters this year on the rate-setting Federal Open Market Committee. But George, who hosts the Fed’s annual policy retreat next week in Jackson Hole, Wyoming, has sounded more dovish than Bullard in recent months, after many years of being viewed as a hawk.
She backed the July hike but dissented in June in favor of a smaller half-point increase, citing concern the larger move could stoke policy uncertainty. Her remarks Thursday continued to tilt dovish.
“I think the case for continuing to raise rates remains strong. The question of how fast that has to happen is something my colleagues and I will continue to debate, but I think the direction is pretty clear,” she said in Independence, Missouri.
“We have done a lot, and I think we have to be very mindful that our policy decisions often operate on a lag. We have to watch carefully how that’s coming through.”
George also noted that the Fed was shrinking its $8.9 trillion balance sheet while raising rates, which would also help to restrain the economy. The pace of decline steps up next month to an annual pace of around $1 trillion.
Fed officials who have spoken since the July meeting have pushed back against any perception that they’d be pivoting away from tightening any time soon. They’ve made it clear that curbing the hottest inflation in four decades is their top priority.

19 Aug 2022

Insight, Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Investment grade credit spreads were generally tighter to start the week and then drifted wider in the second half. The Bloomberg US Corporate Bond Index closed at 134 on Thursday August 18 after having closed the week prior at 132. The 10yr Treasury closed last week at 2.83% and is trading at 2.95% as we go to print on Friday morning. Economic data painted differing pictures this week. The Empire Manufacturing survey on Monday was absolutely dreadful and caused investors to ponder the impact of slowing growth in an economically important region. Housing starts declined for the sixth consecutive month and mortgage applications came in lighter than estimates. On the bright side, July retail sales showed some encouraging signs. Fed speakers throughout the week did their best to remind investors that they will do whatever it takes to lower inflation to 2%. This is not an opinion piece, but since you asked, it is our view that the market is much too complacent about the Fed and there seems to be this prevailing belief that the Fed will be ready and willing to immediately slash the Funds Rate in 2023 at the first hint of economic weakness. We simply disagree with this view and believe that the Fed is willing to inflict pain on equities and riskier assets in its quest to quell inflation. Through Thursday the Corporate Index had a negative YTD total return of -12.23% while the YTD S&P500 Index return was -9.22% and the Nasdaq Composite Index return was -16.69%.

Primary issuance was in line with expectations this week as more than $22bln of new debt was brought to market. As pointed out by Bloomberg, this was the fifth week in a row where actual volume met or exceeded concensus expectations, a good sign for the health of the primary market. Issuance will likely slow significantly until after Labor day at which point we expect substantial issuance if investors remain receptive. There has been $912bln of new issuance YTD which trails 2021’s pace by 5% according to data compiled by Bloomberg.

Investment grade credit reported a fourth straight week of inflows. Per data compiled by Wells Fargo, inflows for the week of August 11–17 were +$3.9bln which brings the year-to-date total to -$111.7bln.

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