GLOBAL CREDIT BULLETS | Monday, 29th November 2021

Covid – New strain fears
On Friday, panic hit markets as a new Covid strain was found in South Africa. The new variant appears highly transmissible, though absolute numbers are still very low. It is unclear whether the variant features some resistance against vaccines. Low vaccine uptake in South Africa suggests the variant needs to be exported to other countries before making any conclusions. Governments have reacted very promptly, with UK and most European countries closing travel with South Africa. For now, very few countries have found cases of such variant, though the number is increasing. Preliminary evidence sees new variant cases as generally milder than previous cases. The market reaction has been strong. European equity indexes lost 4% on the day, with re-opening sectors correcting 7-15%. High beta currencies were down 2%, and credit started widening. Finally, rates tightened 10 bp in a typical risk-off move, despite high inflation and more hawkish Fed. Illiquidity has likely exacerbated the market moves as year-end is approaching. While we have limited visibility on the seriousness of the variant, the reaction has been strong, and many issuers in the hospitality and travel sector are seeing business uptick maintaining a solid financial position. We thus start seeing weakness as an opportunity, especially in equities and convertible.

Turkey – Crisis mode
Last Tuesday, it was a hot one for the Turkish lira. The currency lost 15% over the day, pushed weaker by massive dollar demand from the Turkish public, following the interest rate cuts the week before. The lira is now 30% weaker over the past month, and 60% weaker YTD. The downward spiral in lira is now accelerating fast, and the currency lacks an anchor. Even if foreigners are largely uninvested in the country (unlike previous episodes, eg 2018), the bold monetary easing is triggering a massive loss of confidence domestically, ultimately pushing retails and corporates to rush for dollars. Lira is not new to sudden depreciation, but what’s new is the total absence of policy support. In the past, large depreciation triggered policy reaction, in the form of verbal intervention first and hikes later. This time, the President is re-iterating the country is at “economic war” with the West, suggesting the level of the currency is now less important than the need to stimulate the economy. We still think the current episode may ultimately trigger hikes, as the country does not have many other options. Still, this will clearly take more time, signaling more pressure ahead for the currency and the country financial stability.

Fed – Hawkish surprises
Last Monday, the White House confirmed Powell as chairman of the Federal Reserve, appointing his main challenger, Lael Brainard, as vice-chairman. The move had a hawkish spin, with Powell being perceived as the less accommodative candidate, and Brainard making cautious remarks on inflation a few hours after her appointment. On Wednesday, the Fed published minutes for its November meeting. The tone was hawkish, with MPC members opening to potential hikes and a discussion about potential acceleration of tapering. The minutes confirm a clear shift in the Fed stance: after inflation proved less transitory than expected, the central bank is moving to a more cautious stance, and it’s arguably preparing for a decisive shift to fight inflation, with the revised Fed management being the latest hawkish step. The inflation level and trend suggest an acceleration of tightening may be close, with tapering potentially stepping up in December or January and 2-3 hikes potentially next year. Rates markets have reacted accordingly to the news, with front-end rates widening over the week and 10y crossing 1.6% before Thanksgiving. On Friday, rates tightened massively on lockdown fears. Overall, we remain hawkish on rates into 2022, and continue to see inflation as a permanent phenomenon not fully appreciated by central banks. In 2022, more dovish central banks may turn more hawkish and rates dips in markets where the central bank is hawkish will be an opportunity to hedge duration risk further.