Sarah Harrison, senior portfolio manager at Allspring Global Investments, discusses how she’s seeing a pickup in high-yield issuance and new money deals, particularly this September past, and looks at how the market is reacting to this uptick. She unpacks her investment forecast for fixed income and what she’ll be paying attention to this week.
The senior PM looks at the looming maturity wall of 2024 – 2026. While she believes corporate refinancing fears have largely eased, she notes desks should be paying close attention to warning signals in European default rates and unpacks how to approach this.
Finally, Harrison shares her outlook for earnings and buyback activity for the fourth quarter of 2024, amidst the backdrop of an easing interest rate cycle across the US and Europe.
Interview transcript:
Jo Gallagher Welcome to Trader TV This week your insight into how trading desks can prepare for the week ahead. I’m Jo Gallagher. Today I’m joined by Sarah Harrison at All Spring Global Investors to discuss the main topics and events leading this week. Sarah, welcome to the show.
Sarah Harrison Thanks for having me, Jo.
Jo Gallagher To kick us off, tell us what’s important to pay attention to this week.
Sarah Harrison So there are going to be a couple of data releases that we will be paying attention to over the course of the week. A couple of geographies will be putting out some inflation data. The biggie obviously being U.S. CPI. Chair Powell has telegraphed pretty well what he’s expecting between now and year-end with regard to rate cuts are expecting 25 at each of the next two meetings. But given everything that’s happening in the world, there is obviously the potential for a surprise either to the upside or the downside. And so we’ll be carefully watching that U.S. CPI print to see whether or not we need to adapt our forecasts.
We’ll also be looking at what’s happening in the UK. So we’re going to get some industrial and manufacturing production numbers. The UK has been kind of doing its own thing. So politically it’s going left while the rest of Europe is going right. And then also the Bank of England has been significantly less dovish than the Fed or the ECB. We had Governor Bailey out last week with some remarks about, you know, the BoE perhaps becoming a bit more aggressive. Now that inflation seems to have moved in the right direction. And so, you know, I’ll be interested to see again whether the data supports that narrative and that shift in policy.
These data releases are somewhat overshadowed by what is happening in the Middle East at the moment. What that impact will be on the oil price, the oil price impact on inflation, and the inflation’s impact on what the central bank moves will be going forward.
Jo Gallagher And what are you seeing in terms of inflows and liquidity across fixed income in Q4?
Sarah Harrison September is usually one of the busiest months in the high-yield space from an issuance perspective, and this September has certainly been no exception. We have seen an uptick in issuance and a lot more new money deals. Transaction activity is picking up more LBOs, more M&A and more net new supply for high-yield investors, which has been absolutely welcome because we have been seeing inflows into the asset class and all flavors of high-yield.
So European, global, and US. So this new issuance has been very well digested. And as you know, the direction of travel for interest rates is lower from here. It is a great time to be investing in fixed income.
Jo Gallagher The last time you were on, we discussed the maturity wall. Is that now a distant concern?
Sarah Harrison It was our strong belief going into 2024 that concerns around the maturity wall were overdone. So there was this concern in the high-yield market that a significant amount of maturities had built up for 2024, 2025, and 26. And whether or not issuers would actually be able to deal with these maturities, it was our view that corporate treasurers were simply being savvy about hanging onto lower coupon debt for longer in the face of a higher interest rate environment. And lo and behold, that seems to be playing out for the time being.
2024 maturities have been addressed in a relatively orderly fashion and the maturity wall is showing signs of shrinking as rates have now started to come down and there’s more certainty on the economic outlook. The trailing 12-month default rate in Europe is just under 3%. The trailing 12-month default rate in the U.S. is just under 2%. So very much in line with our view of default rates ticking up, but at the margin and from a very low base.
Jo Gallagher And so what are you seeing in terms of U.S. versus European corporate refinancing?
Sarah Harrison For the first time in a while, default rates in Europe are higher than default rates in the U.S., which is not something that you would naturally think. Given that Europe is generally a higher quality market than the U.S., Europe is about 66% double B’s, whereas the U.S. is 50% double Bs. We do also have a higher distress ratio in Europe.
You know, it’s about a 2% delta between Europe and the U.S. still quite small. But Europe is a more stressed market than the U.S. at the moment. That being said, these numbers are still quite low, still quite manageable. And our view is that Europe is a very interesting hunting ground when you are looking for yield. If you do your security selection properly.
Jo Gallagher And what’s your outlook for activity around earnings and buybacks?
Sarah Harrison There are two main factors that go into a decision on whether or not to pursue buybacks, and that is your cost of financing. And the second is equity valuations, which is of course related to earnings on the cost of financing point. We are very clearly at the beginning of an easing cycle right now. The direction of travel for interest rates is lower.
That being said, there are differing views on what the steepness of that trajectory will look like. In our view, the trajectory will be less steep and what is currently priced into the forward curve, i.e. there will be fewer rate cuts between now and the end of 2025 than the market expects. So yes, the cost of financing for corporate has come down, but not to the point where it’s no-brainer to pursue a share buyback. In fact, in our view, it still makes more sense for corporates to be paying down high coupon debt and deleveraging, which is positive for credit.
On the flip side of that, U.S. equities have been unstoppable this year, but we are starting to see weaker earnings and guidance revisions in some of the more cyclical sectors. You know, you’re seeing some weakness in autos and some weakness in chemicals, not enough to derail the equity market or make buybacks a particularly attractive option yet. But it is something that we are paying close attention to. It’s worth me noting that there have been a couple of sizable dividend recaps in the high-yield market in recent months. But I would not say that this is the start of the trend yet.
Jo Gallagher Thank you, Sarah, for your insights and of course, you for watching This has been Trader TV This Week.
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