This Week: Central banks decide; defaults Vs downgrades, and unlocking year-end liquidity

Published on 11 December 2023

Manuel Hayes, senior portfolio manager at Insight Investments, says that markets could expect some volatility this week as these central banks make their final interest rate decisions for 2023. He also talks through how traders can make the most of a challenging liquidity environment as we come into year-end, he unpacks his views on whether we’re in a default or downgrade regime and discusses what to expect from HY and IG in the new year.

North America

  • US equities volumes climbed week on week, and spreads are around average ranges. US investment-grade volumes break record highs and liquidity remains favourable for year to date..
  • Data: Core Inflation Data out December 12 and Fed’s Interest Rate decision out December 13.
  • In primary equities: There are 4 IPOs expected to price at $48.1 million, the largest should be Trident Digital Tech Holdings.
  • US axe data, which is within normal ranges, indicates a marginally higher proportion of asks versus bids in credit.

Europe and the UK

  • Equities volumes were around average for the year, liquidity worsened marginally week on week. Euro IG volumes were above seasonal averages and liquidity looked favourable.
  • Data: UK Unemployment Rate December 12,  UK GDP on Decemeber 13, and Bank of England and European Central Bank’s interest rate decision on December 14.
  • In primary equities: There are no IPOs expected on European exchanges this week.
  • EU axe data, which is within normal ranges, a much stronger proportion of EU dealer asks versus bids in credit.
  • GBP axe data, within normal ranges, suggests a slight leaning towards net buying versus selling of credit

Transcript of interview:

Jo Gallagher: Welcome to Trader TV This Week. Your insight into her trading desk and prepare for the week ahead. I’m Jo Gallagher.

Today I’m joined by Manuel Hayes from Insight Investment to discuss the main topics and events leading this week.

Manuel, welcome to the show.

Manuel Hayes: Thanks, Jo, for having me.

Jo Gallagher: Before we begin, let’s take a quick look at last week’s activity and what’s coming up.

In North America last week’s US equities volumes climbed week on week and were substantially higher than the level seen for the same week for the last two years. Liquidity saw little movement from the previous week, but purchase price were around average from the same period in 2022. Last week’s US IG volumes remained elevated and continue to break record highs for the year. Liquidity was also very favorable for year to date levels, and for the same week in 2022.

It will be an important week for data. We can expect numbers on core inflation on Tuesday, but most importantly will have the Fed final interest rate decision for the year on Wednesday. In primary equities, we can expect four IPOs to price at $48.1 million in aggregate proceeds, and the largest deal of the week should be Trident Digital Tech Holdings, which is seeking to raise $16.9 million.

U.S. axe data, which is within historical ranges, indicates dealers asks have increased by only half a percent over bids in the past week, suggesting a tiny skew towards selling of credit going into the week ahead.

In Europe and the U.K. last week’s equities volumes fell from the high levels of the previous week, but still raised around average for the year. Liquidity worsened marginally week on week, but bid ask spreads remain tighter than average as seen for the same period in 2022 and 2021.

Last week’s Euro IG volumes fell compared to the end of November, but are still very high for the year and recent seasonal averages. Liquidity continued to look favorable in Euro IG, according to some data readings, and bid ask spreads are half of what they were for the same period in 2022.

This week, the region will also be busy in terms of data with the UK unemployment rate out on Tuesday, the UK’s GDP numbers on Wednesday and both the Bank of England and the EU’s interest rate decision on Thursday. In primary equities there are no IPOs expected to price in European exchanges this week.

EU axe data, which is within normal ranges, indicates the proportion of EU data asks versus bids has increased by a substantial 20.9%. GBP dealer bids are up by a mere 0.4% against asks over the past week, suggesting a very slim leaning towards buying versus sterling of credit going into the week ahead.

Manuel, lots to cover there. Put this week into context for me, what will your trading desk be focusing on?

Manuel Hayes: It’s been a very busy week. We just got out of month end and you saw peak volumes take place after a very aggressive November rally. For context and investment grade, we saw roughly 36 billion traded on month end. In high yield, we saw 15 billion. Usually we don’t see these sort of numbers heading into year end, but given this aggressive November rally we did see a lot of repositioning take place. We saw managers lock in some of those profits that we saw in November, and then also reposition themselves going into year end.

We know the second half of December is fairly illiquid. Wider bid ask, lower trade volumes. You don’t want to get your positioning on that late in the year. So you do it now. And that’s what we saw over the last week.

This week will be very important on the data front and on the liquidity front. On Tuesday you’re going to have inflation numbers. That’s going to be very important given the strong job numbers we saw. Then on Wednesday, the Fed will speak. I think those two days will be centered around a lot of volatility on lower volumes. Following that, on the liquidity front, we believe next week volumes should be slightly less than average, but then afterwards liquidity is going to be very dry. So you got to get your positioning in the next week or so.

Jo Gallagher: Despite the global economic slowdown, why do you argue that it’s good to be in high yield? And what is your outlook for defaults next year?

Manuel Hayes: We’re calling high yield the new growth asset. It’s currently offering 8.25%. So there is a lot of income to harvest there. On top of that, you have defaults which we think are going to be low and benign heading into 2024. So that means you could recoup and harvest a lot of that 8.25%. On the default side we actually think a lot of the defaults are priced in today. This might be the most telegraphed default regime we may see historically. We know the Fed is trying to slow down the economy. The market is efficient for the most part. And so that’s being priced in. So for us we think that High-yield offers a unique source of income diversification and a way to harvest equity like returns.

Jo Gallagher: And why should trading desks be paying close attention to credit downgrades right now?

Manuel Hayes: Our thesis is we’re heading into a downgrade regime as the Fed is trying to slow down the economy. Specifically, we’re looking at that crossover space and credit. The downgrades that are taking place from triple B down to double B’s, or what people refer to as these ‘fallen angels’.

You’ve seen a triple B blow over the past decade in IG, making up less than 50% of the market. We think some of those companies will spill over to high yield. For context, we think that there’s going to be roughly 40 to 50 billion of downgrades in the next 12 months. That’s about historic averages, but it’s meaningful. Over the last two years, we’ve only had 20 billion of downgrades each year. Here I’m saying 40 to 50. So two times that.

As a high yield investor we get excited. As an investment grade investor, you don’t get excited. Why? As an investment grade holder, if you hold one of these downgrades, there’s a lot of selling pressure that happens, spreads widen, indexers for sale and rebalance out of these names, so as an IG investor you want to manage that risk. But as a high-yield investor, if I hear for selling from investment grade indexers to high yield and they come in to the high yield cheap, I get excited. Why would I not want to harvest cheap assets coming to the high yield for no particular reason, except for an inefficient market structure? So I think for us and I think for a lot of investors, this downgrade space will be very important heading into 2024.

Jo Gallagher: How are you specifically finding liquidity opportunities given the high volumes in fixed income trading right now?

Manuel Hayes: Naturally, when you see high volumes, you think there’s going to be lower bid ask or a tighter bid ask. So if you could traffic accordingly, you could find some really unique opportunities to collapse bid asks. For us we’ve actually expanded our toolkit so I could use bonds to trade one bond at a time. I can use portfolio trading. I could do broker inventory collapses on the bond side. But then I also have CDX and I have ETFs. So I have this wider range of tools that I can use at my disposal to implement our strategy and our positioning. So what we’ve seen is there are brokers that want to bring down their balance sheet, and we’ll reduce the cost significantly if you can play into that. In terms of positioning, November is a great data point. It was a very strong rally. If you had cash flows coming in and you weren’t able to implement same day with the broader toolkit, you missed out on a big chunk of this rally.

Jo Gallagher: Thank you, Manuel, for your insight and of course to you for watching.

This has been Trader TV This Week.