The Global Spectrum of Growth
Companies that deliver above-average, sustainable growth over the long term are among the most valuable investments in the markets.
Macro
- Although emerging market central banks were first out of the blocks to hike policy rates in the wake of the pandemic—perhaps serving as a sign that DM institutions would soon follow—we don’t believe EM central banks will signal a turn in the other direction. Our base case suggests that EM central banks may be on the cusp of a tightening pause, but we don’t think they will collectively cut rates until the Fed pauses with its own hiking campaign given the ongoing uncertainty regarding funding conditions, global inflation, and domestic risks (e.g., energy subsidies).
- While further moderation in China’s economic growth, lower commodity prices, and a turn in U.S. data (with a Fed pause or reversal) could contribute to lower EM policy rates, weaker global growth would also mean additional uncertainty. Only EM countries with solid fundamentals and strong credibility would benefit from early rate cuts in that scenario. Local bonds in these countries would also conceivably benefit from early rate cuts, while the FX impact would be more dependent on global conditions. In this scenario, there would likely be limited impact on hard currency IG EM spreads. The effects on HY spreads could be mixed considering the importance of funding conditions and policy direction.
- In the U.S., the level of yield curve inversion—and its perception as a recession indicator—continues to generate headlines. Yet, we’re contemplating whether the curve has become too inverted considering the environment of moderate growth, low unemployment, and above target inflation. Thus, short rates may be slightly too high and long-rate forwards may be too low—indicating that nominal yields five years and out may also be too low. Indeed, the top of a 10-year yield range of 3.5-4.5% would add some notable steepening to the curve.
Rates
- A trio of high-profile central bank meetings are on the docket for next week. In the U.S., following the November payroll report, we’re contemplating whether the terminal Fed funds rate may exceed 4.75% before the Fed pauses until mid-2023 and begins precautionary rate cuts in the second half of the year.
- After a potential 50 bps rate hike next week, we anticipate the ECB may pause for a bit before subsequently hiking 25 bps per quarter to end 2023 around 2.5-3.0%. If nominal wages in Europe show clear signs of rising at levels consistent with inflation running above 2%, the ECB may continue to lift rates without a pause, potentially bringing them closer to 4% by the end of 2023. In the UK, we expect the BoE to raise its bank rate by another 50 bps next week to 3.5%—followed by a pause—before lifting rates toward the 5% area by the end of 2023.
- Last week, U.S. MBS continued to build on gains vs. rates that occurred since mid-October. Better risk sentiment led to decent buying of MBS into and through month-end, leaving the Street as better buyers throughout the week. Short- and long-dated volatility was near unchanged. Thirty-year coupon stack performance favored higher coupons, while lower coupons lagged. The 15-year sector saw similar coupon performance and generally outperformed 30-years on OAS terms.
IG Corporates
- U.S. IG spreads were modestly wider last week. They tightened following Powell's speech before widening out again following the better-than-expected nonfarm payrolls report. Credit Suisse bonds remained volatile amid reported outflows from its wealth management business, with the 10-year bond widening about 40 bps to +500 bps before tightening again to approximately +465 bps following reports that Saudi Arabia's Crown Prince is preparing to invest in CS First Boston.
- New issuance totalled $22B last week versus estimates of $15B-$20B. Books were 2.6x oversubscribed on average with concessions of 6 bps. For December, new issue estimates stand at $25-$35B. Wednesday was the fourth busiest trading day on record as dealers net bought $2.7B over the course of the week. For the month of November, corporate spreads tightened overall with the front-end slightly outperforming. Financials outperformed industrials, led by the banking sector.
- European IG spreads outperformed U.S. and GBP last week as the broad-based rally that began in October continued. Technicals remained strong with the new issue market remaining open but volumes failed to keep pace with ETF demand. Amid a fair amount of new issuance, concessions were smaller and order books were healthy. With just a few more days of new issuance remaining before year-end, it's difficult to see the technical backdrop changing any time soon even as valuation have become less attractive.
- In security specific news, Aroundtown and Grand City jointly decided not to call their upcoming corporate hybrids at the first call date. The market was caught somewhat off guard and the curves for both names sold off. Notably, so did the senior notes as the move was generally seen as a sign of further challenges in the property sector generally.
High Yield
- U.S. high yield bonds posted positive total returns for the fourth consecutive week as technicals remained supportive. All credit tiers were positive, with Bs modestly outperforming. Performance was also positive across all high yield sectors, with homebuilders/materials (1.30%), metals/mining/steel (1.18%), and hotels (1.16%) posting the best performances.
- U.S. high yield bond mutual funds recorded a weekly outflow for the Wednesday reporting period but, based on daily data, high yield funds posted an inflow of $862M for the week ended Friday. While YTD outflows total $42.9B, the net inflows since mid-October highlight the technical strength of the market. Meanwhile, the primary market was silent post-Thanksgiving, with no new issues pricing. We expect to see a small flurry of activity over the next two weeks, but overall volumes for 2022 will end the year significantly lower than 2021.
- There were no new high yield defaults in November for the second consecutive month. Including distressed exchanges, the U.S. high yield default rate increased 2 bps to 1.61%. We continue to anticipate higher default rates over the next 12 months, with the high yield default rate ending next year at approximately 5.0% should the U.S. economy enter a shallow recession.
- U.S. loans saw a modest gain last week with BBs outperforming Bs. The primary market slowed, with two deals allocating and a handful of deals expected to allocate this week. November loan issuance totaled $24.3B (or $8.7B excluding refinancings), which was the highest monthly issuance since April. Still, YTD issuance remains far below that of 2021 at $236B in net volume, which is down 71% year-over-year.
- European high yield bonds and loans posted positive total returns amid limited new issuance. Given a sparse new issue calendar for the remainder of the year, we continue to expect spreads to grind tighter over the next few weeks. However, we remain cautious over the longer term and are mindful of Q4 earnings, the possibility of downside surprises, and the potential for downgrades to pick up in 2023.
Emerging Markets
- Spreads on EM hard-currency bonds continued to tighten last week, by 17 bps for government bonds and 19 for corporate bonds, in both cases led by the high-yield segment. At the macroeconomic level, tighter spreads reflected Fed Chair Jay Powell's less hawkish language on Wednesday last week and headlines hinting at Covid reopening in major Chinese cities, which was earlier than many investors expected.
- At the microeconomic level, Chinese state banks are reportedly preparing U.S.-dollar bond issues with the specific purpose of supporting select property developers at subsidized rates. For example of this impact, prices for the bonds of Chinese property developer Country Garden, which had fallen to less than 10% of par, now trade at over 60%. In our analysis, this positive sentiment may sustain Chinese bonds, especially in the property sector, for some time.
- EM local-currency yields also continued to fall as global inflation appeared to moderate. We continue to focus the portfolios we manage on relative value. We favor, for example, local-currency bonds from those countries where inflation is lower (e.g., Brazil) or where we believe the central bank is nearer the end of its hiking cycle (Mexico). Conversely, we’re underweighting bonds of countries with high inflation or where the central bank is more likely to tighten (Chile, Poland).
- In EM currencies, we continued to reduce our U.S.-dollar exposure, inching towards short U.S.-dollar positioning. In our analysis, positive sentiment relating to China has farther to run. Only a more hawkish Fed could possibly renew U.S.-dollar strength, for example if it points out that its terminal Fed Funds rate is higher than investors currently expect.
- EM bond issuance of $3B was more limited than investor demand last week. Price concessions compared to the secondary market were modest, including for the Colombian U.S.-dollar issue, which we found attractive. EM fund flows remained mixed, with substantial inflows into EM hard-currency bonds and outflows from EM local-currency bonds following their recent rally.
Securitized Products
- U.S. conduit 10-year AAA CMBS spreads rallied another 8 bps last week on increased demand. We continue to recommend staying at the top of the capital structure as CRE fundamentals have increasing uncertainty from both monetary policy and geopolitical risk. Agency CMBS spreads were 6 bps tighter following a rally in the MBS market. Spreads continue their tightening trend: 20-40 bps across the stack last week. Positive technicals should continue with no new issuance remaining this year, few motivated sellers, and increased demand from both MM and HF community. Elsewhere, non-qualifying mortgage spreads tightened by 10bps last week to T+220 bps for AAAs.
- Spreads across the top of the CLO capital structure were generally unchanged, while lower mezzanine tranches were generally firmer last week. We believe spreads for U.S. benchmark issuers are ~3M SOFR+220/300/390/575/950 for AAA/AA/A/BBB/BB, respectively. We have seen recent, increasing demand from some banks and Asian investors. In Europe, total November issuance was ~ €3B across eight deals, well above the 2022 YTD monthly average. Dealers continue to market new transactions in the ~3E+220 bps context.
- ABS spreads were tighter last week on recent light new issue supply and reduced volatility. Trading levels for 3yr senior credit cards, refi private student loans, and unsecured consumer are T+70, T+195, and T+210 bps, respectively. light issuance brought YTD issuance to $236B, 10% behind last year’s pace. ABS collateral performance is expected to continue to trend negatively as the impact of stimulus programs are removed and higher inflation affects affordability, particularly for lower credit cohorts.
Municipal Bonds
- Muni technicals remained positive last week with $916M of inflows driven by ETFs, bringing the YTD total to -$112B. Supply also cooperated with $6.7B, which was 65% of the five-year average. Furthermore, negative supply of $15B is expected in November and December, while supply estimates for 2023 are coalescing around another light supply year.
- Muni performance was positive last week as the market rallied, in line with Treasuries (with the exception of Friday’s post Jobs move). Muni yields have now rallied 60-70 bps off their peaks. While we believe there is a case for positive total and excess returns ahead, we need to be patient for a string of evidence that proves a real trend. Technicals remain supportive, however, open end mutual funds are still experiencing outflows, and current ratios my drag down the rate of reinvestment for banks and insurance companies.
Source(s) of data (unless otherwise noted): PGIM Fixed Income, as 11/28/2022
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U.S. Investment Grade Corporate Bonds: Bloomberg Barclays U.S. Corporate Bond Index: The Bloomberg Barclays U.S. Investment Grade Corporate Bond Index covers U.S.D-denominated, investment-grade, fixed-rate or step up, taxable securities sold by industrial, utility and financial issuers. It includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements. Securities included in the index must have at least 1 year until final maturity and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
European Investment Grade Corporate Bonds: Bloomberg Barclays European Corporate Bond Index (unhedged): The Bloomberg Barclays Euro-Aggregate: Corporates bond Index is a rules-based benchmark measuring investment grade, EUR denominated, fixed rate, and corporate only. Only bonds with a maturity of 1 year and above are eligible.
U.S. High Yield Bonds: ICE BofAML U.S. High Yield Index: The ICE BofAML U.S. High Yield Index covers US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, and at least one year remaining term to final maturity as of the rebalancing date.
European High Yield Bonds: ICE BofAML European Currency High Yield Index: This data represents the ICE BofAML Euro High Yield Index value, which tracks the performance of Euro denominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody's, S&P, and Fitch). Qualifying securities must have at least one year remaining term to maturity, a fixed coupon schedule, and a minimum amount outstanding of €100 M. ICE Data Indices, LLC, used with permission. ICE DATA INDICES, LLC IS LICENSING THE ICE DATA INDICES AND RELATED DATA "AS IS," MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE DATA INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THEIR USE, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND PGIM FIXED INCOME OR ANY OF ITS PRODUCTS OR SERVICES.
U.S. Senior Secured Loans: Credit Suisse Leveraged Loan Index: The Credit Suisse Leveraged Loan Index is a representative, unmanaged index of tradable, U.S. dollar denominated floating rate senior secured loans and is designed to mirror the investable universe of the U.S. dollar denominated leveraged loan market. The Index return does not reflect the impact of principal repayments in the current month.
European Senior Secured Loans: Credit Suisse Western European Leveraged Loan Index: All Denominations EUR hedged. The Index is a representative, unmanaged index of tradable, floating rate senior secured loans designed to mirror the investable universe of the European leveraged loan market. The Index return does not reflect the impact of principal repayments in the current month.
Emerging Markets U.S.D Sovereign Debt: JP Morgan Emerging Markets Bond Index Global Diversified: The Emerging Markets Bond Index Global Diversified (EMBI Global) tracks total returns for U.S.D-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, and Eurobonds. It limits the weights of those index countries with larger debt stocks by only including specified portions of these countries’ eligible current face amounts of debt outstanding. To be deemed an emerging market by the EMBI Global Diversified Index, a country must be rated Baa1/BBB+ or below by Moody’s/S&P rating agencies. Information has been obtained from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan's prior written approval. Copyright 2021, J.P. Morgan Chase & Co. All rights reserved.
Emerging Markets Local Debt (unhedged): JPMorgan Government Bond Index-Emerging Markets Global Diversified Index: The Government Bond Index-Emerging Markets Global Diversified Index (GBI-EM Global) tracks total returns for local currency bonds issued by emerging market governments.
Emerging Markets Corporate Bonds: JP Morgan Corporate Emerging Markets Bond Index Broad Diversified: The CEMBI tracks total returns of U.S. dollar-denominated debt instruments issued by corporate entities in Emerging Markets countries.
Emerging Markets Currencies: JP Morgan Emerging Local Markets Index Plus: The JP Morgan Emerging Local Markets Index Plus (JPM ELMI+) tracks total returns for local currency–denominated money market instruments.
Municipal Bonds: Bloomberg Barclays Municipal Bond Indices: The index covers the U.S.D-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. The bonds must be fixed-rate or step ups, have a dated date after Dec. 13, 1990, and must be at least 1 year from their maturity date. Non-credit enhanced bonds (municipal debt without a guarantee) must be rated investment grade (Baa3/BBB-/BBB- or better) by the middle rating of Moody's, S&P, and Fitch.
U.S. Treasury Bonds: Bloomberg Barclays U.S. Treasury Bond Index: The Bloomberg Barclays U.S. Treasury Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index.
Mortgage Backed Securities: Bloomberg Barclays U.S. MBS - Agency Fixed Rate Index: The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
Commercial Mortgage-Backed Securities: Bloomberg Barclays CMBS: ERISA Eligible Index: The index measures the performance of investment-grade commercial mortgage-backed securities, which are classes of securities that represent interests in pools of commercial mortgages. The index includes only CMBS that are Employee Retirement Income Security Act of 1974, which will deem ERISA eligible the certificates with the first priority of principal repayment, as long as certain conditions are met, including the requirement that the certificates be rated in one of the three highest rating categories by Fitch, Inc., Moody’s Investors Services or Standard & Poor’s.
Palmer Square AAA CLO DM Index represents the discount margin of CLO AAA rated tranches in the Palmer Square CLO Senior Index, which is designed to reflect the investable universe of U.S CLO senior original rated AAA and AA debt issued after Jan 1, 2011.
Global Aggregate Bond Index is a measure of global investment grade debt from twenty four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Index covers the U.S.D-denominated, investment-grade, fixed-rate or step up, taxable bond market of SEC-registered securities and includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS sectors. Securities included in the index must have at least 1 year until final maturity and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
Euro Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, euro-denominated, fixed rate bond market, including treasuries, government-related, corporate and securitized issues. Inclusion is based on currency denomination of a bond and not country of risk of the issuer.
Japanese Aggregate Bond Index The Japanese Aggregate Index contains fixed-rate investment-grade securities denominated in Japanese yen and registered as domestic bonds. The index is composed primarily of local currency sovereign debt but also includes government-related, corporate, and securitized bonds.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over U.S.D 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately U.S.D 3.4 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
The DAX Index is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. The equities use free float shares in the index calculation. The DAX has a base value of 1,000 as of December 31, 1987. As of June 18, 1999 only XETRA equity prices are used to calculate all DAX indices.
The STOXX 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalization companies across 17 countries of the European region.
The Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. The Nikkei Stock Average was first published on May 16, 1949.
Shanghai Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The index was developed on December 19, 1990.
MSCI ACWI is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1987. MXWD includes both emerging and developed world markets.
FTSE 100 is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. The equities use an investibility weighting in the index calculation. The index was developed with a base level of 1000 as of December 30, 1983.
MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of volatilities on the CT2, CT5, CT10, and CT30. (weighted average of 1m2y, 1m5y, 1m10y and 1m30y Treasury implied vols with weights 0.2/0.2/0.4/0.2, respectively).
VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.
Bloomberg Commodity Index Bloomberg Commodity Index (BCOM) is calculated on an excess return basis and reflects commodity futures price movements. The index rebalances annually weighted 2/3 by trading volume and 1/3 by world production and weight-caps are applied at the commodity, sector and group level for diversification. Roll period typically occurs from 6th-10th business day based on the roll schedule.
The U.S. Dollar Index indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. The ICE US computes this by using the rates supplied by some 500 banks.
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