Insight – Page 21 – Cincinnati Asset Management

11 Apr 2022

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

2022 Q1 Investment Grade Quarterly

It was an extremely painful start to the year for credit markets as performance suffered due to wider spreads and higher interest rates. During the first quarter, the option adjusted spread (OAS) on the Bloomberg US Corporate Bond Index widened by 24 basis points to 116 after having opened the year at an OAS of 92. Interest rates finished the first quarter higher across the board. The 10yr Treasury opened the quarter at 1.51% and closed 83 basis points higher, at 2.34%. The move in the 5yr Treasury was even more dramatic as it rocketed higher by 120 basis points, from 1.26% to 2.46%. The 2yr Treasury saw the most movement of all with a 160 basis point increase from 0.73% to 2.33%. The extreme move higher in interest rates led to negative returns for fixed income products across the board. The Corporate Index posted a quarterly total return of ‐7.69%, its second worst quarterly return in history. The only quarter that was worse than this one was the 3^rd quarter of 2008 in the midst of the Great Recession when the index posted a quarterly return of ‐7.80%. CAM’s net of fees 1^st quarter total return was ‐6.75%.

You own bonds, now what?

Is now the time to panic? While we are certainly disappointed with short term negative performance we believe investors that are committed to the asset class will be rewarded over a longer time horizon. The thesis for owning investment grade credit as part of an overall diversified portfolio has not changed. Investors look to highly rated corporate bonds for diversification, income, and to decrease the volatility of their overall portfolio. While higher Treasury yields have led to negative performance for the past quarter it has also led to opportunity with investment grade yields that are now at their highest levels since the spring of 2019. Higher yields mean that newly issued corporate bonds will have larger coupons and more income generation.

For those who may view recent returns as a signal to either enter or exit certain asset classes, we would caution against such an attempt at market timing that currently might lead one to exit the investment grade corporate bond market. This is especially true when credit conditions are strong and the loss of value that occurred during the quarter was almost entirely driven by interest rates and not by the general creditworthiness of the investment grade universe. It is important to remember that bonds are a contractual obligation by the issuer – the bonds will continue to inch closer to maturity and pay coupons along the way. An investor who has seen a bond decrease in value will recapture some portion of that value over time in the form of coupon payments and an increase in principal value as the bond rolls down the yield curve toward maturity and its price converges toward par.

During the first quarter we experienced dramatically higher Treasury rates along with wider credit spreads. To put it into historical context, it was the second worst quarter for the Corporate Index since its inception in 1973. It is not easy to step in and buy here amid negative sentiment regarding the Fed and interest rates but we believe that is precisely what investors should be doing.

Credit Conditions

The investment grade credit markets were in very good health at the end of the first quarter. The secondary market has been liquid and the primary market was fully functioning, even during the volatile period for risk assets that coincided with early days of Russia’s invasion of Ukraine. Cash on investment grade non‐financial firms’ balance sheets was at all‐time highs at the end of 2020 and 2021.ⁱ Leverage ratios for IG‐rated issuers spiked during the early innings of the pandemic but leverage has since come down substantially and is now below pre‐pandemic levels.ⁱⁱ In 2020, due to the early severity of the pandemic, there were $186bln in downgrades from investment grade to high yield. That trend reversed sharply in 2021 with just $7bln in downgrades during the entire year while there were $35bln in upgrades from HY to IG. 2022 will go down in history as the “year of the upgrade” and there were $31bln in upgrades during the first quarter of 2022 alone.

J.P. Morgan has identified an additional $230bln of HY‐rated debt that could make its way to investment grade by the end of 2022. There is a high probability that 2022 will shatter records for the most upgrades during a calendar year. As far as the new issue market is concerned, the numbers have been very strong. March was the 4^th busiest month on record for the primary market with $229.9bln in volume. There was $453.4bln of new issuance through the end of the first quarter, which was 4% ahead of the pace set in 2021.ⁱⁱⁱ In aggregate, the investment grade universe is strongly positioned from the standpoint of credit worthiness and access to capital. We believe this is supportive of credit spreads.

Inflation, Interest Rates, the Fed: Impact on Credit

Inflation and interest rates are understandably a hot topic in our discussions with investors. Inflation is a problem, and headline PCE, which is the Fed’s preferred inflation gauge showed a year‐over‐year increase of

+6.4% for its February reading.^iv Chairman Powell has responded with forceful rhetoric that the FOMC will do everything in its control to reign in price increases and the market has bought in. The consensus view is that inflation will slow throughout 2022. Along those same lines, it is widely anticipated that economic growth will slow throughout 2022 as well. At this point it seems likely that the Fed will raise its target rate by 50 basis points at its May and June meetings and then it could raise by 25 basis points in July, September, November and December. This is largely priced in at this point.^v The risk with the Fed’s stance on inflation is that it could start to aggressively tighten monetary policy just as consumer spending begins to decline thus lighting the fire for a recession. History shows that it is very difficult for monetary policy to fight inflation and avoid a recession at the same time, thus the odds of a recession at some point over the next two years has increased substantially. Note that a recession simply means the economy has had two consecutive quarters of negative GDP growth –it is not a good thing, but a modest shallow recession does not necessarily mean economic disaster.

For credit, slower or negative growth likely means wider spreads but we would expect investment grade to outperform other risk assets in such a scenario. Investment grade balance sheet fundamentals are very strong and margins had been expanding until very recently and are near their peak. At some point, inflation will start to take a bite out of margins for some industries but in aggregate corporate credit is in very good health and well positioned to weather a storm. If the Fed manages to achieve its goal of a soft landing then that would be a scenario where risk assets perform reasonably well, but it could be accompanied by interest rates that inch higher from here, which would be a headwind for longer duration credit. An additional risk is that neither inflation nor economic growth decline in line with expectations throughout the rest of 2022; although we believe that this is the less likely of the two scenarios, it does remain a possibility that this path comes to fruition. If this happens then the Fed will have to become uber‐hawkish and may have no choice but to force the economy into recession to cool inflation.

What Does an Inverted Yield Curve Mean for Credit?

As a reminder, at CAM we position client portfolios in intermediate maturities. We typically purchase bonds that mature in 8‐10 years and then allow those bonds to roll down the yield curve, holding them for 3‐5 years before we sell and redeploy the proceeds into another bond investment. We do this because the 5/10 portion of both the Treasury curve and the corporate credit curve have been historically typically steep relative to the other portions of both of those curves. We prefer a steep 5/10 Treasury curve but at the end of the 1^st quarter that curve was ‐12 basis points. Our strategy still works when there is an inverted Treasury curve because there is a corporate credit curve that trades on top of the Treasury curve that classically steepens when the Treasury curve flattens resulting in extra compensation for incremental duration. See the below chart that compares the Treasury curve at quarter end against the corporate credit curves of two bond issuers:

Note that the curve for Charter is steeper than Progressive. This is typical given that Charter is a lower quality credit than Progressive; the curve should be steeper for incremental credit risk. Curves are moving all the time and change by the day or even by the hour. To provide some recent historical context, the 5/10 Treasury curve was 80+ basis points just one year ago, which was its steepest level at any time in the previous 5 years –things can change quickly. Corporate curves also vary by industry with fast changing industries like technology typically having steeper curves than stable more predictable industries. It is the constant monitoring of these curves and the subsequent implementation of trades where an active manager adds value to the bond investment management process.

There are a variety of reasons that Treasury curves invert but the main reason comes down to Federal Reserve policy and its impact on the front end of the Treasury curve. Increasing the Federal Funds Rate has a disproportionate impact on Treasuries that mature in 5 years or less and especially those that mature in 2 years. Longer term Treasuries like the 10yr are much more levered to investor expectations for economic growth and longer term inflation expectations. We would note that this Treasury curve inversion is still very fresh and corporate credit curves have steepened moderately in the meantime. Over time, if Treasuries remain inverted, we expect to see more steeping of corporate credit curves.

Looking Ahead

It has been a tough start to the year but it is only April and there is still much to be written before we close the book on 2022. There are significant unknowns and risk factors that loom large as we navigate the rest of the year. The largest geopolitical uncertainty is the Russo‐Ukrainian War but China’s “zero‐Covid” policies are another risk that may not be fully appreciated by the markets as a slow‐down in China could have significant ramifications for global economic growth. Domestically, Federal Reserve policy is at the forefront and there are also mid‐term elections in the fall.

We believe higher Treasury yields and reasonable valuations for credit spreads along with healthy credit conditions for investment grade issuers have made the investment grade asset class as attractive as it has been in several years. The risk to our view is that Treasury yields could go even higher from here creating additional performance headwinds for credit.

We will be doing our best to navigate the credit markets in a successful manner the rest of this year and we appreciate the trust you have placed in us as a manager. Thank you for your business and please do not hesitate to contact us with any questions or comments.

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 Goldman Sachs Global Investment Research, March 28 2022, “IG capital management: Deleveraging is the exception, not the rule”

ⁱⁱ Bloomberg, Factset, Goldman Sachs Global Investment Research

ⁱⁱⁱ Bloomberg, March 31 2022, “IG ANALYSIS: Corebridge Debut Closes Out Record $230bln Month”

^iv CNBC, April 1 2022, “The Fed’s preferred inflation gauge rose 5.4% in February, the highest since 1983”

^v Bloomberg, March 14 2022, “Fed Traders Now Fully Pricing In Seven Standard Hikes for 2022”

11 Apr 2022

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

2022 Q1 High Yield Quarterly

In the first quarter of 2022, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was ‐4.84% while the CAM High Yield Composite net of fees total return was ‐ 6.11%. The S&P 500 stock index return was ‐4.60% (including dividends reinvested) over the same period. The 10 year US Treasury rate (“10 year”) had a steady upward move as the rate finished at 2.34%, up 0.83% from the beginning of the quarter. During the quarter, the Index option adjusted spread (“OAS”) widened 42 basis points moving from 283 basis points to 325 basis points. Each quality segment of the High Yield Market participated in the spread widening as BB rated securities widened 38 basis points, B rated securities widened 29 basis points, and CCC rated securities widened 76 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years.

The Energy, Other Financial, and REITs sectors were the best performers during the quarter, posting returns of ‐2.54%, ‐2.73%, and ‐3.82%, respectively. On the other hand, Banking, Communications, and Utilities were the worst performing sectors, posting returns of ‐7.27%, ‐6.54%, and ‐5.71%, respectively. Clearly the market was weak as all sectors posted a negative return in the period. At the industry level, oil field services, independent energy, and leisure all posted the best returns. The oil field services industry posted the highest return 3.05%. The lowest performing industries during the quarter were wireless, food and beverage, and banking. The wireless industry posted the lowest return ‐11.79%.

The energy sector has been quite topical. Crude oil had a $45 per barrel range in Q1 and averaged $92 per barrel. Meanwhile, the natural gas market also moved steadily higher during the quarter reaching highs not seen in nine years. OPEC+ members are “refusing to deviate from their schedule of gradual production increases.”ⁱ They are also refusing to discuss the Russia‐Ukraine conflict with the last few meetings lasting less than fifteen minutes. Russia is a significant member of the broader group. Therefore, there likely needs to be much more political wrangling before the group takes a stand against one of their own.

During the first quarter, the high yield primary market finally took a break after three years of strong issuance. The weak market led by rising rates kept companies on the sidelines as only $45.8 billion posted in the quarter. Consumer Discretionary did continue to lead and took 33% of the market share. Second place was Materials at 12% of the total. Wall Street strategists have begun to lower their full year issuance forecasts. However, there isn’t much concern for lack of capital access due to issuers being so proactive with refinancing in the past few years.

The Federal Reserve did lift the Target Rate by 0.25% at their March meeting. That was the first increase since 2018. The chart to the left shows the updated Fed dot plot post the March meeting. Of note, the Fed median Target Rate for 2022 increased from 0.875 to 1.875. Such movement is a clear indication of the dynamic economic backdrop. Furthering the point, Fed Chair Jerome Powell commented just days after the March meeting, “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.”ⁱⁱ He then went on to say, “And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.” These moves are being driven by a tight employment market and inflation that is running higher than any point in the last 40 years. The Fed is undoubtedly looking to bring inflation lower while keeping the economy at some sustainable growth rate.

Intermediate Treasuries increased 83 basis points over the quarter, as the 10‐year Treasury yield was at 1.51% on December 31st, and 2.34% at the end of the first quarter. The 5‐year Treasury increased 120 basis points over the quarter, moving from 1.26% on December 31st, to 2.46% at the end of the first 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 fourth quarter GDP print was 6.9% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 3.4% with inflation expectations around 6.2%.ⁱⁱⁱ Worth mentioning is the yield curve inverting for the first time since 2019. Historically, inversion is an indication of pessimism in the growth outlook and concern of a nearing recession. The recent reports have been split between “the sky is falling” and “this time is different,” neither of which seems all that compelling at the present moment. Perhaps a more appropriate view is one attributed to Barclays. They suggest looking at the current environment in terms of recession probabilities. Based on their model, recession probabilities are not elevated coming in at roughly 20%. This is leading them to currently have the view that inflation is likely to brake rather than break the growth outlook.

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market outperformed during 2021. Thus, our higher quality orientation was not optimal last year.

That higher quality focus continued to have a tough time against the rising rate environment during Q1, as it is the most rate sensitive group within the broader high yield market. As a result and noted above, our High Yield Composite net of fees total return did underperform the Index in Q1. The higher quality positioning was the sizeable negative contributor relative to the Index, slightly offset by the cash position in an overall negative total return market.

The Bloomberg Barclays US Corporate High Yield Index ended the first quarter with a yield of 6.01%. The market yield is an average that is barbelled by the CCC rated cohort yielding 9.06% and a BB rated slice yielding 5.00%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 25 over the quarter with a spike to a high of 36 as the market sold off during the first two and a half months of the year.

For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The first quarter had two bond issuers default on their debt. The trailing twelve month default rate fell to 0.23%. The current default rate is relative to the 4.80%, 1.63%, 0.92%, 0.27% default rates from the previous four quarter end data points listed oldest to most recent. The fundamentals of high yield companies are in great shape as leverage, profit margins, and debt servicing all look good. From a technical view, fund flows were negative in all three months of the quarter. The 2022 year‐to‐date outflow stands at $28.5 billion.^iv 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 any price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are at historic lows and fundamentals are at highs. Further, as the quarter closed, the market saw a weekly inflow, only the second of the year. Additionally, market returns coincidently bottomed just as the Fed started raising rates. That seems interesting to say the least. Naturally, 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.

The backdrop as we move into the second quarter of 2022 is quite intriguing. Inflation is at four decade highs, the yield curve is inverting, recession fears are bubbling, supply chain disruptions are ongoing, energy markets are heading skyward, the Federal Reserve is starting a hiking cycle, and there is a war that has the attention of the entire world. But, the market just had the biggest weekly gain in over fifteen months, rising stars are at a record pace, companies are in solid financial shape, and default rates are extremely low. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. 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.

i Bloomberg March 31, 2022: OPEC+ Stands Back as Oil Consumers Move to Ease Prices

ii Bloomberg March 22, 2022: Powell Is Ready to Back Half‐Point Hike

iii Bloomberg April 4, 2022: Economic Forecasts (ECFC)

iv Wells Fargo March 31, 2022: “Credit Flows”

08 Apr 2022

High Yield Weekly 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 $0.5 billion and year to date flows stand at -$28.0 billion. New issuance for the week was $6.0 billion and year to date issuance is at $49.1 billion.

(Bloomberg) High Yield Market Highlights

The U.S. junk bond market is set to close the week with losses after declining for three straight sessions and yields rose 25 basis points to a three-week high of 6.32%, rising 25bps week-to-date amid broader market volatility.
“Risk assets sold off this week in light of increased hawkishness from the Federal Reserve,” Brad Rogoff, Barclays’ head of fixed income research, wrote on Friday.
The primary market priced $6b this week to make it the busiest for new issuance in two months after the slowest first quarter since 2016, with just $43b
Junk bond investors pulled cash from high yield funds in 11 of the 13 weeks in the first quarter, but are showing signs of demand again
U.S. high yield funds report a modest inflow of $0.5b for the week, the second consecutive week of inflows

(Bloomberg) Markets Bet on Sharpest Pace of Fed Tightening Since 1994

Money-market traders are betting the Federal Reserve is heading for its most aggressive monetary-policy tightening in almost three decades as it fights a commodity-driven inflation spike.
They are pricing in a further 225 basis points of interest-rate hikes by the end of the year on top of the 25 basis points delivered in March.
Minutes of the Fed’s March meeting released Wednesday showed that “many” officials would have preferred to raise rates by a half percentage point but were deterred by Russia’s invasion of Ukraine. Only St. Louis Fed President James Bullard dissented in favor of a half-point hike. The Fed also signaled it will reduce its massive bond holdings at a maximum pace of $95 billion a month, further tightening credit to cool inflation.
The Fed hasn’t done that much tightening — 250 basis points — in one year since 1994, a famously brutal year for bond investors that even included a 75 basis-point hike. The last year there was more tightening was in the early 1980s, when Paul Volcker was in charge of the central bank. Treasuries have already lost 6.7% this year, heading for the worst annual return since Bloomberg started compiling the data in 1973.
With U.S. inflation heading for 8%, a rate not seen in 40 years, Fed officials have adopted a decidedly more hawkish tone. The latest move in market bets began Tuesday after Governor Lael Brainard said the central bank will continue tightening monetary policy methodically.
In a reversal of a recent trend, the yield curve has steepened since Brainard commented Tuesday that the Fed will shrink its balance sheet “considerably more rapidly than in the previous recovery.” The 10-year yields traded 8 basis points higher than two-year notes, after dipping below the shorter-maturity rate last week for the first time since 2019. The curve inversion last week stirred concern that the Fed’s tightening may raise the risk of a recession over time.
“The implication here is that over time, the balance-sheet reduction will lead to an increase in the term premium, which in turn will put upward pressure on the long end of the curve,” Tim Duy, chief U.S. economist at SGH Macro Advisors, wrote in a note to clients.
The minutes showed participates agreed that the maximum monthly reduction of its bond holdings, composed of $60 billion in Treasuries and $35 billion in mortgage-backed securities, would “likely be appropriate.”

25 Mar 2022

High Yield Weekly 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 -$3.9 billion and year to date flows stand at -$31.1 billion. New issuance for the week was $2.8 billion and year to date issuance is at $39.2 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk-bond investors turned to fast-food operator Yum Brands in the primary market on Thursday after inflation concerns, a hawkish Federal Reserve and the war in Ukraine drove issuance to the slowest month in two years. Yum Brands sold $1b 10-year notes, rated Ba3/BB, at 5.375%, the lower end of price talk, after underwriters received orders more than $2.9b. The bond sale was increased by $500m to $1b.
With yields volatile, borrowers are tapping the market when windows of opportunity arises to refinance or to fund acquisitions that have to close soon.
YUM Brands sold primarily to refinance 7.75% 2025 notes that were callable on April 1.
“The overall fundamentals are solid, with leverage back to pre- pandemic levels and higher interest coverage, which should provide a cushion against near-term macro risks and rising rates,” Barlcays’s strategist Brad Rogoff wrote on Friday.
U.S. junk bonds held steady for the second straight session as yields and returns were largely flat and equities rallied amid a broader risk-on sentiment.
While there was no serious loss of risk appetite or rising default fears priced into recent new issues, investors pulled cash out junk bond funds following a rise in yields and increased volatility.
The U.S. high yield funds reported an outflow for the 11th consecutive week and the longest streak of outflows since 2007.

(Bloomberg) Powell Is Ready to Back Half-Point Hike in May If Necessary

Federal Reserve Chair Jerome Powell said the central bank is prepared to raise interest rates by a half percentage-point at its next meeting if needed, deploying a more aggressive tone toward curbing inflation than he used just a few days earlier.
Policy makers raised the benchmark lending rate by a quarter point at their meeting last week — ending two years of near-zero borrowing costs — and signaled six more hikes of that magnitude this year, based on the median projection. Powell indicated that half-point hikes may be on the table when policy makers next gather May 3-4 and at subsequent sessions.
“If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” Powell said in a speech titled “Restoring Price Stability” to the National Association for Business Economics on Monday.
Following his formal remarks, Powell was asked by the moderator if there was anything stopping policy makers from hiking by a half point in May, which would be the first increase of that magnitude since 2000.
“What would prevent us? Nothing: Executive summary,” he said, drawing laughs from the audience. He added that such a decision had not been made, but acknowledged it was possible if warranted by incoming data.
“My colleagues and I may well reach the conclusion that we’ll need to move more quickly and if so we will do so,” he said.
Powell was more hawkish on Monday than at the press conference following last week’s meeting, indicating that if inflation continues to run hot he would favor a more aggressive pace of tightening. Last week he had to speak for the range of views among the 16 policy makers currently on the Federal Open market Committee.
Markets heard the chair’s message and moved sharply in response, sending Treasury yields spiking higher as investors increased bets that the Fed will raise interest rates by a half point in May to confront the hottest inflation in 40 years.
Goldman Sachs Group Inc.’s economists led by Jan Hatzius saw the comments as a hawkish signal and now expect the Fed to raise interest rates by 50 basis points at both its May and June policy meetings, followed by four 25 basis point increases in the second half of the year.

18 Mar 2022

High Yield Weekly 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 -$2.4 billion and year to date flows stand at -$27.1 billion. New issuance for the week was $1.0 billion and year to date issuance is at $36.4 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are poised to post the biggest weekly gains in almost three months after Fed Chair Jerome Powell highlighted the strength of the economy, fueling the largest three-day rally in equities since November 2020.
As the Federal Reserve began what is likely to be its most aggressive rate-hike campaign in two decades, Powell said the economy was strong and well-positioned to withstand tighter monetary policy.
Still, “a sustained rally will require more clarification about peak inflation and the economic ramifications of the ongoing Russia-Ukraine war,” Barclays’ strategists Brad Rogoff and Dominique Toublan wrote on Friday.
The rates curve indicates that persistently higher inflation will lead to higher short-term rates and could weigh on longer-term growth prospects, Barclays wrote.
The gains in high-yield debt were across the board, with CCCs, the riskiest part of the market, on track to close the week with the biggest advance in three months after rallying for two straight sessions.
Junk bond yields dropped 17bps to 6.12% on Thursday and spreads tightened 17bps to +369.
BB yields dropped 16bps to close at 5.01%, the biggest one-day fall in more than three months.
The Ba index posted gains of 0.69% on Thursday, and is likely to see the biggest weekly returns in three months, with gains of 0.4% so far.
The primary market was still quiet as borrowers wait for the markets to settle down after the FOMC decision to raise rates by 25bps, while indicating further 25bps hikes at each of the next six meetings.
The issuance volume stands at $36b year-to-date, the slowest first quarter since 2016, according to data compiled by Bloomberg.

(Bloomberg) Fed Lifts Rates a Quarter Point and Signals More Hikes to Come

The Federal Reserve raised interest rates by a quarter percentage point and signaled hikes at all six remaining meetings this year, launching a campaign to tackle the fastest inflation in four decades even as risks to economic growth mount.
Policy makers led by Chair Jerome Powell voted 8-1 to lift their key rate to a target range of 0.25% to 0.5%, the first increase since 2018, after two years of holding borrowing costs near zero to insulate the economy from the pandemic. St. Louis Fed President James Bullard dissented in favor of a half-point hike, the first vote against a decision since September 2020.
“The American economy is very strong and well positioned to handle tighter monetary policy,” Powell told a press conference Wednesday following a meeting of the Federal Open Market Committee. “I saw a committee that is acutely aware of the need to return the economy to price stability.”
The hike is likely the first of several to come this year, as the Fed said it “anticipates that ongoing increases in the target range will be appropriate,” and Powell repeated his pledge to be “nimble.”
In the Fed’s so-called dot plot, officials’ median projection was for the benchmark rate to end 2022 at about 1.9% — in line with traders’ bets but higher than previously anticipated — and then rise to about 2.8% in 2023.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the FOMC said in its policy statement following the two-day meeting in Washington, the first held in person — rather than via videoconference — since the pandemic began. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
The Fed said it would begin allowing its $8.9 trillion balance sheet to shrink at a “coming meeting” without elaborating. Powell said officials had made good progress this week in nailing down their plans and could be in a position to begin the process at their May meeting, though the FOMC had not taken a decision to do so. The purchases of Treasuries and mortgage-backed securities, which concluded this month, were intended to provide support to the economy during the Covid-19 crisis and shrinking the balance sheet accelerates the removal of that aid.
In new economic projections, Fed officials said they see inflation significantly higher than previously anticipated, at 4.3% this year, but still coming down to 2.3% in 2024. The forecast for economic growth in 2022 was lowered to 2.8% from 4%, while unemployment projections were little changed.
The pivot to tighter monetary policy is sharper than policy makers expected just three months ago, when their median projection was for just three quarter-point rate increases this year.
The Fed previously held off from raising rates as officials bet the inflation shock would fade once the economy returned to normal following the pandemic recession and lockdowns, though they were also cautious amid new Covid-19 variants and data showing a choppy jobs recovery.
Instead, price gains accelerated amid a mixture of massive government stimulus, tightening labor markets, surging commodity costs and frayed supply chains. Powell has also been operating under a Fed policy framework, adopted in mid-2020, to allow some above-target inflation in the hope of broadening employment.
President Joe Biden has called taming inflation his top economic priority, while fellow Democrats worry failure to restrain prices could cost them their thin congressional majorities in November’s midterm elections.

18 Mar 2022

Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

The trend of wider spreads was broken in a big way this week as credit is poised to finish the week meaningfully tighter. The OAS on the Bloomberg US Corporate Bond Index closed at 127 on Thursday, March 17, after having closed the week prior at 143. Spreads hit their widest levels of the year on Monday with a close on the index of 145 and Tuesday wasn’t much better at 144 but then the sentiment shifted in a big way on Wednesday and Thursday as spreads ripped tighter on the back of strong demand from all types of investors. As expected the FOMC began a tightening cycle on Wednesday with a quarter point raise of the Federal Funds Rate. The messaging from the Fed was slightly more hawkish than expected which resulted in some weakness in the Treasury market and slightly higher rates. The Fed appears to be committed to curbing inflation while attempting to engineer a soft landing for the economy. The Investment Grade Corporate Index had a negative YTD total return of -8.36% through Thursday. The YTD S&P500 Index return was -8.6% and the Nasdaq Composite Index return was -14.1%.

The primary market was reasonably busy this week with $29 billion in debt having been brought to market. Per Bloomberg, this boosted the monthly total for March to over $158bln. There is a reasonably good chance that we could see over $200bln in new issuance before the month is over with consensus estimates calling for $30bln in supply next week.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week. Outflows for the week of March 10–16 were -$4.3bln which brings the year-to-date total to -$26.9bln.

11 Mar 2022

Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Spreads are wider week over week in what seems to have become a recurring theme. The tone of the market is mixed as we go to print this Friday afternoon but market participants remain wary of risk. Geopolitical turmoil in Europe remains at the forefront but there have been other challenges and there are more ahead –the market survived the highest CPI print in over 40 years on Thursday morning and all eyes are looking toward the FOMC meeting next Wednesday. The OAS on the Bloomberg US Corporate Bond Index closed at 141 on Thursday, March 10, after having closed the week prior at 130. The Investment Grade Corporate Index had a negative YTD total return of -7.9% through Thursday. The YTD S&P500 Index return was -10.6% and the Nasdaq Composite Index return was -16.1%.

The primary market had its 8^th busiest week on record and volume will approach $70bln by the end of the week. Magallanes, which is the WarnerMedia SpinCo for assets that AT&T is selling to Discovery Communications, led all issuers this week with a $30bln debt deal across 11 tranches. This was the fourth largest bond offering in history. Next week should continue to see a brisk pace of issuance as it is well known that Oracle will soon be in the market to finance its acquisition of Cerner and there are other issuers waiting in the wings as well. We have mentioned this in previous notes but it bears repeating; even amid widening spreads, geopolitical uncertainty and a pivot in Fed policy, the investment grade new issue market remains wide open and the secondary market is showing signs of good liquidity and two-way flow with low transaction costs.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week. Outflows for the week of March 3–9 were -$4.7bln which brings the year-to-date total to -$19.3bln.

11 Mar 2022

High Yield Weekly 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 -$1.3 billion and year to date flows stand at -$27.4 billion. New issuance for the week was $0.5 billion and year to date issuance is at $35.4 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are headed toward the biggest weekly loss in 17 months as yields jump to a fresh 20-month high after inflation accelerated and the war on Ukraine intensified.
Continuing volatility drove investors to pull cash from retail junk-bond funds for the ninth straight week, the longest losing streak since 2007
U.S. high yield funds reported an outflow of $1.3b for the week
The escalating war has increased the economic pressure on Russia, with the U.S. now calling for the end of normal trade relations, clearing the way for increased tariffs on Russian imports
The sanctions are expected to spur inflation even higher and slow economic growth
Bloomberg economist Anna Wong forecast that U.S. inflation could hit 9% as early as March or April with oil at $120 a barrel, and may end the year close to 7%
Bloomberg economists have lowered 2022 U.S. GDP growth forecast to 2.5% from 3.6%
The benchmark U.S. high yield index posts a loss of 1.29% week-to-date after reporting negative returns in three of the last four sessions
The losses were across the board in the high yield market. BBs were leading the pack with week-to-date losses of 1.34%
BB yields, the most rate-sensitive in the high yield market, also climbed to a 20- month high of 5.08% amid widespread fears of inflation disrupting growth
CCCs are poised to post the least losses, with 1.20% week-to-date, while yields rose to a 16-month high of 8.82%
The junk bond primary market has been quiet as borrowers have stayed away, waiting for some clarity on macro risks
The primary market has slowed to a crawl
The issuance volume was about $36b year-to-date, the slowest first quarter since 2009
As of Friday morning, the markets may recover as U.S. equity futures edged higher amid reports that some progress is being made in talks between Russia and Ukraine

(Bloomberg) U.S. Inflation Hit Fresh 40-Year High of 7.9% Before Oil Spike

U.S. consumer price gains accelerated in February to a fresh 40-year high, consistent with rapid inflation that’s become even more pronounced following Russia’s invasion of Ukraine.
The consumer price index jumped 7.9% from a year earlier following a 7.5% annual gain in January, Labor Department data showed Thursday. The widely followed inflation gauge rose 0.8% in February from a month earlier, reflecting higher gasoline, food and shelter costs. Both readings matched the median projections of economists in a Bloomberg survey.
Excluding volatile food and energy components, so-called core prices increased 0.5% from a month earlier and 6.4% from a year ago.
The data illustrate the extent to which inflation was tightening its grip on the economy before Russia’s war brought about a spike in commodities, including the highest retail gasoline price on record. Most economists had expected February would be the peak for annual inflation, but the conflict likely means even higher inflation prints in the coming months.
To combat building price pressures, the Federal Reserve is set to raise interest rates next week for the first time since 2018. At the same time, the geopolitical situation adds uncertainty to the central bank’s rate hiking cycle over the coming year.
Fed officials could take a more hawkish stance if energy price shocks lead to higher and more persistent inflation, but they also may take a more cautious approach if sinking consumer sentiment and declining real wages begin to weigh on growth as the war drags on.
The February report showed that gasoline prices rose 6.6% from the prior month and accounted for almost a third of the monthly increase in the CPI. Some of that may reflect energy price spikes resulting from the first days of Russia’s invasion during the last week of the month. The impact will be more fully captured in the March CPI report.
So far this month, the retail price of a regular-grade gasoline has increased 19.3% to $4.32 a gallon, according to American Automobile Association data.

Food prices climbed 1% from the prior month, the largest advance since April 2020, the CPI report showed. Compared with February last year, the 7.9% jump was the biggest since 1981.

04 Mar 2022

Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

For the second consecutive week, spreads will finish a Thursday evening at the widest levels of the year. The tone of the market is also feeling heavy this Friday morning as we got to print amid geopolitical fallout from Europe. The prospect of a nuclear incident at a Ukrainian facility is not something the markets are taking lightly. On the domestic front, the Friday morning jobs report showed that U.S. hiring was strong in February with employment numbers handily beating consensus estimates along with an unemployment rate that edged lower, to 3.8%. This news likely keeps the Federal Reserve on track to begin its hiking cycle at its meeting later this month. The OAS on the Bloomberg US Corporate Bond Index closed at 125 on Thursday, March 3, after having closed the week prior at 121. The Investment Grade Corporate Index has posted a negative YTD total return of -5.8% through Thursday. The YTD S&P500 Index return was -8.4% and the Nasdaq Composite Index return was -13.5%.

The primary market was extremely active this week with 31 deals totaling over $53bln with at least one deal pending on Friday that will add to this total. This speaks to the resiliency of the investment grade credit market– even amid geopolitical uncertainty; the market remains open for business in a big way. Next week’s consensus forecast is calling for things to remain busy with predictions of more than $40bln in new issue. March is typically a seasonally busy month for issuance and it appears that 2022 is no exception.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week. Flows for the week of February 24–March 2 were -$2.1bln which brings the year-to-date total to -$14.7bln.

04 Mar 2022

High Yield Weekly 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 -$0.4 billion and year to date flows stand at -$26.0 billion. New issuance for the week was $1.7 billion and year to date issuance is at $34.9 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are headed to the first back-to-back weekly gains since December with the risk-off mood easing after Federal Reserve Chair Jerome Powell said U.S. economic growth was strong enough to warrant a quarter-percentage-point interest rate hike this month.
That buoyed a market that had been weighed down by uncertainty over the economic outlook and the scope of the Fed’s coming interest rate hikes; traders last month speculated that the Fed could begin with a half-point rate increase.
Even as the war in Ukraine intensifies and commodity prices soar, credit market technicals have held up, Barclays’ strategist Brad Rogoff wrote on Friday, though he added that spreads could come under pressure near-term.
While sustained higher energy prices pose downside risks to the outlook, Barclays does not view them as sufficient to derail the recovery, Rogoff wrote.
Yields have been resilient through the week, closing unchanged at 5.66% week-to- date.
The 5-year and 10-year Treasury yields fell about 13bps week-to-date at close yesterday at 1.73% and 1.84%, respectively.
Spreads closed at +358bps, just up by 5bps
Junk bonds gained across ratings for the second straight week, with 0.21% returns for BBs, 0.22% single Bs and 0.15% CCCs.
CCCs have lost some momentum and were the worst performing segment for the second consecutive week, pushing single Bs to the top.
U.S. high yield may be in a holding pattern as equity futures slide and European stocks tumble to a one-year low as war risks intensified. Oil, meanwhile, is headed for the biggest weekly surge in almost two years after Russia’s invasion of Ukraine roiled global markets.

(Bloomberg) Powell Backs Quarter-Point March Rate Hike, Open to Bigger Moves

Federal Reserve Chair Jerome Powell backed a quarter-point interest-rate hike this month to commence a series of increases and didn’t rule out a larger move at some stage, despite uncertainty caused by Russia’s invasion of Ukraine.
“I am inclined to propose and support a 25 basis-point rate hike,” Powell told the House Financial Services Committee Wednesday. “To the extent that inflation comes in higher or is more persistently high than that, then we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings.”
Fed officials are pivoting to tackle the fastest inflation in 40 years and a few have publicly discussed the potential need to hike by a half point some time this year if inflation comes in too hot. They get February data on consumer prices on March 10, five days before they start their next policy meeting.
While acknowledging the uncertainty posed by the attack on Ukraine, Powell said the need to remove pandemic policy support had not changed.
“The bottom line is that we will proceed but we will proceed carefully as we learn more about the implications of the Ukraine war for the economy,” he said.
Investors increased their bets on the pace of rate hikes this year as the Fed chief spoke, pricing in around 140 basis points of tightening starting this month — which will mark the first increase since 2018. U.S. stocks advanced and 10-year Treasury yields rose on Powell’s message that the economy is expanding with enough force to withstand higher borrowing costs.
Powell said the labor market is “extremely tight,” essentially a message to lawmakers that the central bank has met its maximum employment goal in current conditions, which opens the door to its inflation fight. He said employers are having difficulties filling job openings, while workers are quitting and taking new jobs, helping wages rise at the fastest pace in years.
“We know that the best thing we can do to support a strong labor market is to promote a long expansion, and that is only possible in an environment of price stability,” Powell said, restating a line he has used several times now that interprets the inflation fight in terms of preserving the expansion.
The Fed chief said it wasn’t clear how high rates would have to rise to get inflation under control, in relation to the so-called “neutral” level that neither speeds up nor slows economic activity.
“We talk about getting to neutral, which is a neutral rate which would be somewhere between 2% and 2.5%. It may well be that we need to go higher than that. We just don’t know,” he said, adding that he believed it was possible to deliver that tightening without causing a recession.

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