US Inflation – More downside
Last week’s CPI print confirmed the falling trajectory of inflation in the US, reinforcing our view that we are past the peak. On a YoY basis, the December headline CPI decreased to 6.5% from 7.1%. Core inflation came in at 5.7% compared to 6.0% in November. Overall, the fall in inflation was mainly driven by a decline in gas prices which significantly offset the price increases in shelter, food and clothing.
December’s print marked the 6th consecutive monthly decrease in inflation, putting the Fed on track to slow the pace of interest rate hikes. We believe that falling inflation and recent remarks from FOMC members increase the chance of a 25bp hike at the next Fed meeting in February. Following the data release, the market prices ~28bp and ~47bp hikes in the 2 upcoming meetings, with a terminal rate of ~5% to be reached in June.
Credit markets – Bullish start
Credit markets started the year on a positive note, continuing the positive trajectory we saw in the last quarter of 2022. The Bloomberg Global Aggregate Index is up 3.3% YTD, US and European High Yield are up 3.9% and 2.6%, respectively and EM hard currency is up 2.5% YTD. As growth slows and rates stabilize, we think investment grade and defensive sectors will outperform. Financials are set to benefit, given they are well represented in IG indexes and their fundamentals remain strong. EMD is interesting again (on a selective basis), as positioning is light and benefits from rates stability. China re-opening and bearish positioning in Europe means non-US assets will outperform. As we mention in our latest Algebris Bullet, historically, a slowing economy and lower US rates means that credit, Treasuries, EM debt and HY bonds outperform.
In credit, technicals are also looking better. 2023 new issuance started with a bang. In the US, high grade issuers took advantage of the first window of opportunity available, with $34.1bn pricing on the first day of the year. This was the 8th busiest supply day on record. In Europe, the first 2 weeks saw c.€66bn in new supply in IG, compared to ~€40bn in 2022, ~€35bn in 2021 and the 5y average of €32bn for the same period. The bulk of the supply came from banks, which tend to front-load their issuance as much as possible. Unlike the investment grade market, euro high yield pricing has so far not been validated by normalised levels of supply, as issuers remain reluctant to lock-in higher funding costs. Looking at the weeks ahead, we do not expect this pace of supply to be maintained.
BoJ – Hawkish change in the making
This week, the Bank of Japan will review the side-effects of its monetary easing and is likely to examine policy options, including potentially shortening the maturity of its yield curve controls. The BOJ will be keen to present any such move as aimed to reduce distortions in financial markets prompted by prolonged easy policy, and to avoid any suggestion that it would represent a reduction of its easing stance.
In December, the BOJ surprised markets by doubling the tolerated range of its 0% 10-year target yield to +/- 0.5%, prompting investor speculation it was preparing to move away from easy policy. Governor Haruhiko Kuroda also surprised some BOJ board members by failing to emphasise a continuing commitment to easy policy at the December press conference.
At this meeting, we believe one possibility would be to shift the targeted yield from 10- to three- to five-year bonds, which BOJ analysis indicates are the crucial maturities for maintaining activity and providing stimulus. The BOJ would again promise to buy as many JGBs as necessary to keep yields within the target range.
Overall, December’s move has failed to address distortions caused in the bond market from the BOJ’s massive bond buying, heightening market speculation. However, we expect the overnight policy interest rate to remain unchanged at -0.1%, and for the yield curve control to remain in place, albeit with potential tweaks.
Algebris Investments’ Global Credit Team
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