This week the Fed decides and markets could face ‘systemic’ issues in debt markets

Published on 29 April 2024

Francesco Castelli, head of credit strategy at Banor Capital

Francesco Castelli, head of credit strategy at Banor Capital, discusses his very different outlooks for activity and liquidity across the US and Europe this week—amid the upcoming US’s Fed interest decision (Fed decides) and EU public trading holidays.

As markets now believe the high-interest rate environment to stick around for quite some time in the US and Europe, there are growing concerns that contentious debt negotiations between corporates and creditors, such as firms Altice and Lumen, could become “a systemic problem” with widespread implications on credit market liquidity.

Castelli tells Trader TV how he and his front office team are approaching the refinancing issues across the High Yield and how they deal with corporate issuers.

The head of credit strategy also unpacks his views on where there are opportunities and risks to pay attention to when it comes to US Vs European banks.

We have an extended version of the show only available to our email subscribers. In the full show, Francesco Castelli offers insights into how he and his team work with traders to find the best prices and achieve the best outcomes for investors.

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Interview Transcript

Jo Gallagher, presenter There’s been an uptick in market volatility over the last few weeks. But credit markets have done exceptionally well this year. Put into context, how has liquidity been across fixed income overall in your view and what do markets have in store for this week?

Francesco Castelli Liquidity has been surprisingly good, especially if you consider that government bonds around the world on average are down 5%. So very bad start to the year for government bonds, despite a very good start in credit as you were mentioning.

Liquidity is also managing to survive the quantitative tightening enacted by major central banks. So surprising liquidity on one hand. On the other side, the monetary policy is getting tighter than expected.

We are expecting seven cuts at the beginning of the year. Now the number of cuts expected is just down, probably to one if anything. And that’s why the 1st of May is going to be a very important day in the US with the Fed meeting. There will be no liquidity at all in Europe—with Labor day, 1st of May.

So everybody will be on holiday in Europe, whereas they are going to be very, very busy listening to Powell on the other side of the pond. And Chair Powell will give us some indication when they think they might start easing rates at the moment that the markets expect the beginning of November as a possible date.

Jo Gallagher, presenter We’ve had a big year as well for debt refinancing, and we’ve had some high profile names like Lumen and Altice trying to renegotiate their debt. Are these anomalies or is there more of a systemic issue here?

Francesco Castelli The big problem is that we are seeing effort to renegotiate the debt from companies in different sectors with a single common thread. All these companies have overleveraged in past years, and now they are facing a very different reality. As we know, interest rates are much higher and interest rate costs are probably two times, maybe three times higher than they were for these companies.

The big problem for us investors, as these companies are trying to shift the burden and the losses onto bondholders. So far, liquidity remains good because I think market participants, including myself, are perceiving risks as company specific idiosyncratic.

The big problem for liquidity and for the asset class is going to be once we come to the realization that these renegotiations are going to be systemic and going to spread to different companies.

That’s the risk scenario to have in mind,  the scenario in which liquidity will be withdrawn because retail investors, institutional investors, will start to reduce their allocation to the asset class and will make life much more difficult for issuers and institutional investors such as ourselves.

Jo Gallagher, presenter Given those concerns in High Yield, how are you accounting for those in your investment trading strategies over the next few months?

Francesco Castelli Well, we are very prudent on the High Yield as a whole. We try to stress test every single issuer. So again, the refinancing and interest rate costs doubling maybe trebling is the main problem for the sector. So we make sure that we invest in high [quality] companies that are able to afford this, as far as the level of interest rate is concerned.

Another thing we like is a shifting from industrial High Yield to subordinated bonds issued by banks. It’s kind of strange because generally when you see problems and troubles on the horizon, you would generally shift away from banks.

Banks have been the more volatile type of debt in the last few financial crisis, but we think banks have graduated now. They have much stronger balance sheets, and so they will be able to withstand the economic volatility in a much, much better way than all that kind of debt.

Of course, we’re talking about European banks. U.S. banks, especially regional banks, are slightly different time, in our view, are in a weaker situation. So we’re focusing on European banks at the moment.

Jo Gallagher, presenter

Thank you Francesco for your insight and of course you for watching.

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(Fed decides, fixed income liquidity, debt, systemic problems, markets)