Fixed Income Monthly Report - June 2023
Preview of our monthly publication with macro themes and single bond ideas
Every month, we publish the Fixed Income Monthly report. The report is a synthesis of the Ashenden’s team view on Fixed Income, pursuing a global approach through the full spectrum of the asset class and providing bond picks. We range from Investment Grade bonds to High Yields & Emerging Markets.
In the report we disclose our bond model portfolio (6 years track record) with more than 60 individual names. We include new single bond ideas, switches, new entries and exits.
All this is corroborated by a bottom-up analysis for each single position (new and old) and merged with a top-down consideration so to include the key market drivers.
This is one of the research piece our team produces internally. The intent of the report is to support wealth managers/asset managers in their decision and allocation process.
Underlying you can find a summary of what you can find inside this report.
June edition content
Tech thrives amid economic uncertainty
Major tech stocks surged in May, leading U.S. stocks slightly higher even as the U.S. potentially facing a technical default dominated market attention. The S&P 500 index posted a gain of 0.4% in May and is up nearly 10% so far this year. But a few large technology firms are driving those gains as they capitalize on the escalating interest in artificial intelligence. This contributed significantly to the solid Nasdaq performance at +8%. However, applying equal weighting to all companies in the index shows it is down over 1 % this year extending 2022’s hefty losses.
This comes at a time when both global fixed income and equity markets have been moving sideways for several weeks, awaiting new catalysts. Despite being exposed to fluctuations in growth data, equities have managed to maintain their year-to-date gains. This absence of a clear market direction is reflected in the extremely low realized volatility, which in turn influences implied volatility.
The technology sector has seen significant outperformance. This success can be attributed to the very recent declines in policy rate expectations and better-than-expected earnings. However, the sustainability of this outperformance is questionable. With policy rate forecasts more likely to increase rather than decrease, the coming quarters may not see earnings exceed expectations to the same extent. This could potentially lead to a deceleration in the technology sector, which has been a key market driver.
Interestingly, some sell-side strategists, frustrated by the lack of a clear market direction, have started to show signs of capitulation. Equity strategists from financial powerhouses like Citi, Bank of America, and Morgan Stanley have all recently increased their year-end S&P targets. Concurrently, they have once again postponed their predictions for a recession, now pushing it into 2024.
Global growth cools, yet recession remains at bay
Despite earlier optimism spurred by China's reopening, global recovery is not progressing as rapidly as expected. This slowdown is supported by both hard data and confidence indicators. Additionally, the conference board U.S. leading index, along with other similar indices, signals a looming recession in the U.S.
Sceptics have been waiting patiently for the recession, one that has been widely anticipated but has yet to materialize, particularly in the U.S. In the first quarter, U.S. economic growth slowed significantly. The GDP rose at an annualized rate of 1.1%, falling short of the consensus forecast of 1.9% and the 2.6% growth rate recorded in the fourth quarter.
Consumer credit remains available, albeit at a higher cost, which might become a burden over time. Rising consumer loan delinquencies at commercial banks are a sign of financial stress. While delinquency rates remain still relatively low by historical standards (even if drifting upward), any further deterioration may signal a recession.
Recent U.S. debt ceiling crisis. On May 27th situation improved, with President Biden and House Speaker McCarthy reaching an agreement to raise the debt ceiling while also imposing a cap on federal spending. The deal, which suspends the debt ceiling until January 2025 in exchange for spending caps and cuts in government programs, could result in spending freezes, necessitating more independent operation of the economy. Nevertheless, market participants remain wary about the potential impact of the proposed spending caps on specific sectors and the overall U.S. economy.
Credit rating for U.S. government debt. On May 23, Fitch Ratings placed U.S. sovereign debt on negative watch, noting “the brinkmanship over the debt ceiling negotiations” and the failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges.
Treasury’s need to replenish cash in the Treasury General Account (TGA), which is the federal government's operating account to handle daily public money transactions. The debt-ceiling standoff has left the TGA uncomfortably low (below $50 billion, compared with a recent balance of more than $500 billion). Replenishing the account could require the Treasury to issue $730 billion in Treasury bills over the next three months and about $1.25 trillion for the rest of the year. This expected burst of T-Bill issuance could have consequences for liquidity in other markets with the heightened risk of market volatility.
In mid-June, central banks such as the ECB, the Fed, the BoJ and the BoE will hold their policy meetings. Central banks are expected to remain restrictive until there is evidence of a sustained return towards the inflation target. While there has been a lot of debate about the magnitude of an economic slowdown and the prospects of recession, inflation remains far away from the ECB’s or the Fed’s target. We think central banks will remain in restrictive territory until evidence of a long lasting return towards the inflation target emerges.
Against this backdrop, the relative calm that pervades markets may not be sustainable. Volatility in equity, rates and credit markets appears relatively contained and well below March levels.
Global credit markets on a tightrope
Global credit markets are currently in a mid-range state when viewed from a year-to-date or the past twelve-months perspective. The credit landscape is characterized by a low supply which has effectively counterbalanced the withdrawal of Quantitative Easing support. The stabilization of rates has managed to counter some moderation in growth. With average spreads, decent yields, and little volatility, credit presents an ideal carry asset. However, the stability of credit is subject to change if fundamental risks increase, which could lead to a more volatile environment.
We are of the view that such a risk is concrete, primarily because credit conditions are getting tighter. This tightness in credit conditions is evident across both the US and Europe's debt markets, with the issuance of CCC-rated securities at its lowest point in a decade. Additionally, banks' lending surveys depict tightest lending standards, the most rigid outside of a recession. This typically triggers a drastic deceleration in credit growth, which is detrimental for the economy, and could lead to an increase in credit risk, defaults, and downgrades.
Market participants are hoping for a 'goldilocks' scenario where inflation decreases rapidly and slower growth has only a minimal impact on profit margins. However, we speculate that earnings could be under pressure during a period when credit conditions are tightening.
Recently, there has been some upward pressure on bond yields, mainly driven by the short end of the curve but we maintain our concerns about future profits, prompting us to adopt a defensive stance on equities and credit. Given the cumulative impact of the Fed's rate hikes and slowing credit growth in the wake of regional banking sector turmoil, we anticipate that S&P 500 earnings may fall short of expectations.
Our medium-term outlook remains gloomy, sticky inflation, subpar growth and central banks still in tightening mode. The current market setup, instead, points to a more rosy scenario resulting in investors reducing their cash and short-term bond holdings, while increasing their equity allocations. However, we believe that we are not at this stage yet and that prices of risky assets will drop before recovering. As such, our recommendations remain unchanged from last month.
Our view is that investors should consider high-quality Investment Grades and exercise extreme selectivity when dealing with High Yields and Emerging Markets.
Next, we updated our monthly model portfolio, studying its performance and adding new bond ideas:
New ideas
Ideas reiterated and business case updates
Exits
The fixed income model portfolio includes Investment Grade and High Yield bonds.
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thank you, great take!