Dissecting the Fed, Commercial Real Estate Risks, and EU Credit

Published on 24 July 2023

Art DeGaetano, CIO and founder of Bramshill Investments, discusses how trading desks should direct their attention this week as markets are pricing in further interest hikes from the US and European central banks. DeGaetano also unpacks his less conventional take on regional bank risk to commercial real estate; he talks about where to find overlooked opportunities and his view of the European credit markets.

North America

  • Equities volumes are still low and spreads are wide for the year to date. US Investment-grade volumes rebound and spreads remain tight.
  • In primary equities: We have several IPOs in Healthcare, Tech, and Materials on the New York Stock Exchange and Nasdaq.
  • Data: Fed Rate Decision, July 26. US GDP, July 27. Earnings e.g. Microsoft, Meta, and Amazon.
  • US axe data, which is within normal ranges, indicates a higher proportion of buying versus selling in credit.

Europe and the UK

  • Equities volumes are low but spreads are tight for 2023. EU Investment-grade volumes fell week on week but liquidity has stabilized.
  • In primary equities: We have several IPOs in Healthcare and Tech on the London Stock Exchange.
  • Data: ECB’s rate decision July 27. Earnings e.g. UBS, Barclays, and Ryanair.
  • EU axe data, which is within normal ranges, suggests a higher proportion of EU dealer asks versus bids in credit.
  • GBP axe data, within normal ranges, suggests much higher net buying Vs selling of credit.

Transcript of interview:

Jo Gallagher: Welcome to Trader TV This Week.

In North America last week’s equities volumes were low and spreads were wide as a summer slump continued. However, US IG spreads appeared to stabilize.

This week, markets will be paying close attention to the Fed’s rate meeting and any potential surprises in earnings.

In Europe and the UK last week’s volumes across assets also saw a big drop off yet liquidity seemed to average out. This week, markets will be looking to the ECB’s rate decision on July 27th and any signs of future policy easing.

Now in more detail.

In North America, the summer lull continues as equities volumes last week were still very low. For the rolling year to date average. Liquidity has worsened week on week, likely due to the drop in market participation, and bid ask spreads are very wide for the year. Last week’s US investment grade volumes have bounced back from the lows of the last few weeks and are ranging around average levels for 2023. Bid ask spreads and IG, week on week, saw little change but are tight for the year.

In primary equities this week we can expect many IPO’s in healthcare, tech and materials on the New York Stock exchange and NASDAQ. Coming up we’ll have an eventful week; on July 26th, much of the market is anticipating the Fed will increase interest rates by another quarter basis point. And on July 27th we’ll get us GDP and core PCE numbers. We’ll also have a busy rollout of earnings with some of the biggest tech firms expected to release their Q2 performances, including Microsoft, Meta and Amazon.

US axe data, which is within historical ranges, indicates dealers bids have increased by 2% over USC’s in the past week, suggesting a slight increase in net buying of credit going into the week ahead.

In Europe and the UK, Equities volumes dropped further last week and continued to be low for the year to date average. While liquidity saw little difference week on week, bid ask spreads remained very tight for 2023 levels. US investment grade volumes fell last week and are low for the year to date average. Liquidity has worsened week on week, But bid ask spreads in Europe IG are generally around normal ranges for the year.

This week in primary equities, we can expect IPOs in tech and healthcare on the London Stock Exchange. In Europe, markets will be awaiting the ECB’s interest rate decision on July 27th and will be watchful for any signals on future policy outlooks. The region will also be monitoring some of the large cap earnings this week, such as UBS, Barclays and Ryanair. EU axe data, which is in normal ranges, indicates the proportion of EU dealers asks vs bids has increased by 5%. GBP dealer bids are up by 1.9% against asks over the past week, suggesting a slight leaning towards buying vs selling of credit going into the week ahead.

Jo Gallagher: I’m Jo Gallagher and now joining me to discuss the week ahead, we have Art DeGaetano, CIO & Founder, Bramshill Investments.

Art, welcome to the show.

Art DeGaetano: Thank you for having me. Very excited to be here today.

Jo Gallagher: Starting off with North America, what will your traders be focusing in on this week? And do you see any volatility ahead?

Art DeGaetano: So this week, the big item on the docket is the Federal Reserve meeting on Wednesday. We actually don’t anticipate significant volatility this week because it’s well built in to market expectations that they will move a quarter point. More importantly, forward guidance wise is next month towards the end of August when the Fed meets in Jackson Hole. And usually that’s where your Federal Reserve chairmans are a little more free to chat about forward direction. We think that’s going to be a bigger market mover. We’re positioning very lightly as a firm. We have a very low gross, we’re not taking any leverage. We do not have many shorts on, but we are running significant cash like positions, so three and six month Treasury to stay very liquid for the next few months.

Jo Gallagher: There’s a lot of concern around exposure to rates and regional banks. What is your take on this?

Art DeGaetano: We’ve done a fair amount of work on the regional bank exposure to see our commercial real estate. We’ve come away with not as dire of a worry. If there was a building ten years ago that was $100 million and you had 20 million of equity in 20 mezz and the top 60 million was at the bank level, a lot of those buildings are 50, 60% occupied. They also need to be refurbished and have maintenance. And everyone is aware that the interest rates were probably 5%. Now they’re upwards of of eight or nine. So most of the equity and mezz are in trouble there.

The banks getting hit $0.60 on the dollar where its probably what the building is worth. So we think the haircuts will be less given where they already have a lower exposure on the capital stack. And as a result, it’s going to be more change of ownership. So you might see the earnings per share at some of the banks be weak. But from a credit standpoint, we think you’re safe to buy senior secured debt. You want to be more in new builds. So 2020-2021 type of vintage which have higher occupancy rates and have locked in financing on a forward guidance level. That’s very attractive from a relative value standpoint.

Jo Gallagher: Where are you seeing certain opportunities in the credit markets and what is being overlooked?

Art DeGaetano: We’re looking at BDC debt at the corporate level, trading $0.80 to 0.85 on the dollar. You’re looking at seven and a half percent triple B’s. It’s probably too early to invest there, so we’re getting more prepared. That’s an area that’s exciting to us. I think there will be an opportunity, but you want to see it play out as some of this private credit market seasons more heading into 2024 when the refi issue is going to be significant.

Jo Gallagher: And now looking across here, how would you be trading credit in those markets?

Art DeGaetano: Europe is interesting where defaults are already approaching 4%. Second quarter of 2022, the average yield on a loan was about 5%. As of this month, it’s 9%. Given the geopolitics in the backyard, we’re not as constructive on the growth prospects of Europe. I do think even though delinquencies and defaults have been rising, there will probably be more drama in the US as we go through 2024. Just simply because Europe in general is a less levered corporate arena, so you know, the banks do a decent job of making sure their loan losses are preserved and that they have pro formaed it out in more of a distressed scenario. So as far as European credit, it definitely has cheapened and it is relatively cheap to the US. I think US has more probability of a draw down vs Europe.

Jo Gallagher: Thank you, Art for your insight and thank you for watching.

This has been Trader TV This Week.