Bracing for Volatility: Debt Ceiling Tensions, Banking Unrest and Surging Issuance

Published on 22 May 2023

Cathy Gibson, global head of trading at Ninety One discusses how traders should prepare for a potentially chaotic week ahead amid fears of a US default, the ongoing pressures on regional banks and the flood of bond issuance in the market.

North America

  • Equities volumes are down week on week but bid-ask spreads are wide year to date. Investment-grade bond volumes are high and liquidity has been good.
  • The cost of credit protection for Financials was up by 0.2% and short interest levels in Tech fell by 4.2%. 
  • Markets will be watchful of the US Debt Ceiling negotiations, data on US GDP Growth, Initial Jobless Claims, and Core PCE Prices.
  • US axe data, which is within normal ranges, indicates a higher proportion of buying versus selling in credit.

Europe and the UK

  • Equities volumes dropped and bid-ask spreads widened. Bond bid-ask spreads were tighter week on week.
  • The short interest levels in Energy fell by 9.4%. 
  • Data to look for this week: UK Inflation Rate and Producer Prices on Wed. Germany GDP data on Thurs.
  • EU axe data, which is within normal ranges, suggests a higher proportion of EU dealer bids versus asks in credit.
  • GBP axe data, within normal ranges, suggests much higher net selling Vs buying of credit.

Transcript of Interview:

Jo Gallagher: Welcome to Trader TV this week.

In North America volumes and liquidity have been mixed across assets. This week could be quieter for equities, yet fixed income markets could be busy, given the recent highs in issuance and volumes.

In Europe and the UK, equity saw wide bid ask spreads yet liquidity in bonds has improved week on week. Trading activity could be low to moderate across assets unless we see any major surprises in upcoming economic data.

Now in more detail. In North America last week’s equities volumes were slightly lower than the prior week and our low for year to date levels. Bid ask spreads were significantly tighter, indicating liquidity improved week on week, but spreads are still wide relative to this year. Last week, volumes for US investment grade bonds were up significantly compared to the second week of May, reaching highs not seen since end of March.

Bid ask spreads have tightened week on week and are tight overall for 2023.

US corporate debt issuance was extremely high last week and fixed income traders could be busy if this continues into this week. By Friday, the cost of credit protection for diversified financials in the US rose by a mere 0.2%. But short interest levels in tech stocks fell by 4.2% this week. Traders will be closely watching any progress on the US debt ceiling, as well as data on US GDP growth and initial jobless claims on Thursday.

On Friday, we can also expect data on core PCE prices. US axe data, which is within historical ranges, indicates dealer spreads have increased by 2.6% over asks in the past week, suggesting an increase in net buying of credit going into this week.

In Europe and in the UK, equities volumes last week dropped significantly compared to the week prior and were very low for year to date ranges. Traders also saw poor liquidity in the region as bid ask spreads were wider than the previous week, and overall for this year.

Volumes for euro investment grade bonds saw little change compared to the week previous, whereas tertiary did see a major drop off in activity. Generally, volumes appear to run normal levels for the year. Bid ask spreads were tighter week on week and are tight compared to yearly averages. By Friday last week, the short interest levels across European energy stocks fell by 9.4%. This week, traders will be watchful for data on the UK’s inflation rate and producer prices on Wednesday. Germany’s GDP growth data on Thursday, and on Friday we’ll see numbers on UK retail sales.

EU axe data, which is within normal ranges, indicates the proportion of EU dealers bids versus asks has increased by 6.1%. GBP data asks are up by 1.9% against bids over the past week, suggesting a skew towards selling versus buying of credit going into the weekend.

I’m Jo Gallagher. And joining me to discuss the week ahead, we have Kathy Gibson at 91. Cathy, welcome to the show.

Cathy Gibson: Jo, it’s a pleasure to be here.

Jo Gallagher: Now, looking at North America, what are some of the things that traders in that region might react to this week?

Cathy Gibson: I think traders in our region will very much still be thinking about the debt ceiling negotiations taking place in the US. Optimism increased towards the tail of last week when Biden made comments that we were nearly at an agreement. And broadly, the global markets rallied on the back of this with the exception of the Hang Seng, which closed 2.4% down on the back of Alibaba’s disappointing sales figures. The key to these negotiations is to avoid the first ever US default in history. The negotiations are themselves probably a bit more political than they are economic at this point. Bottom line is, it’s in no one’s best interest for a default. So I believe that an agreement is very close to hunt.

Jo Gallagher: Is the US banking term over with now?

Cathy Gibson: High inflation, high interest rates, I think it’s going to put additional pressure on regional banks. As much as 50% of the business and industrial loans comes from those banks, 45% of the consumer loans and as much as 60% of the residential mortgages. In the longer term, you could well see regulators increasing capital and liquidity coverage ratios, which again will put extra stress on the bank. So I think you’ll see further mergers and acquisitions in that space in the medium to long term. And I think there is still risk in the short term of ad hoc events.

Jo Gallagher: Last week we also saw a high proportion of bond issuance and Neptune data tells us that there’s a higher proportion of buying versus selling of the US dollar credit and Europe credit. Why is that and how might that impact trading activity this week?

Cathy Gibson: Last week we saw the fourth largest bond issuance in history, with Pfizer placing its $31 billion in a tranche deal, which was very much so oversubscribed. You also saw some big deals in Europe come to market. What that means for trading is that it will stimulate the secondary market where particularly in bonds, you’ve seen volumes here today, probably 20 to 30% behind where they usually are. And I think you’ll see that pick up as people start to realize they’ve done their risk reallocations earlier this year.

Jo Gallagher: And looking across Europe, what are some of the main things that traders in that region need to be prepared for this week?

Cathy Gibson: I think traders need to prepare for new primary issuance and then the turnover that’s going to create in the secondary flow. There’s a few political things going on. We had the G7 summit in Japan where European leaders will no doubt be discussing Ukraine and China in great detail. Re-elections, we also have Greek elections on the 21st and then we have Turkey, which will go to a runoff ballot. Traders need to be positioning themselves around volatility, around events like that, So you need to be conscious of where your risk is versus the benchmark and be adjusting accordingly.

Jo Gallagher: And we’re finding that there are two very different pictures when it comes to US and EU inflation. What are the risks and opportunities traders might derive from those?

Cathy Gibson: All regions are currently trying to tackle inflationary pressures and you can see that in the US, on the back of ten consecutive interest rate hikes and I think currently we’re about 35% priced in to have another hike. There’s very different views as to how best to position and it varies whether across real money and banks.

In Europe and the UK it’s slightly different. Again, recessionary pressures are at the forefront and it’s probably only when those recessionary pressures come into full force that you’ll see the interest rate hiking cease and even start to cut.

Jo Gallagher: Thank you, Cathy, for your insights and thank you for watching. This has been Trader TV this week.