GLOBAL CREDIT BULLETS | Monday, 17th January 2022

US rates – Hawks are in the air.
The environment for US rates keeps turning more hawkish. On Wednesday, the December CPI displayed a 7% increase yoy, making new multi-year highs. With energy prices more stable in December, core items turned to be the main driver of the print (though used cars still play an important role). Higher levels and core drivers point to more persistent inflationary dynamics, scoring another point against “team transitory”. On the Fed side, commentary is turning more hawkish too. In last week testimony in front of the Senate, the Fed chairman reiterated availability to hike this year if inflation warrants it, and pointed to balance sheet runoff once tapering has been completed. Since then, a flurry of officials have publicly commented on the number of hikes, with several members pointing to the possibility of four hikes, with a cycle starting as early as March. Inflation data remain as strong as they have been since summer, but the Fed finally adapted to the new reality. Front-end rates are pricing hikes correctly, but real yields remain in firmly negative territory and the US curve remains very flat, suggesting the market is pricing some “back to normal” once 2022 hikes are gone. As such, we see more room for adjustment in rates markets with consequent more volatility in global equity and credit.

Bond markets – Tectonic shifts.
Higher US rates are leading to broad outflows in bond markets. Since the start of the year, major bond US ETFs saw almost $5bn in outflows, after relative stability in 4Q21. As a result, the price action in bond markets has been negative. Emerging markets continue to be the underperformers, in late with the second half of last year, but some weakness started also in more resilient areas, such as US high yield or subordinated financials. Bond outflows and reduced central bank purchases are likely to be important headwinds for fixed income markets in 2022. Moreover, issuance and financing needs will be similar to 2021, but in presence of lower demand, worsening the technical picture. A rich macro agenda in the next few weeks, with Fed and ECB meetings and a strong focus on China data, may create further triggers for bond weakness. We continue to see pocket of values, such as front end cyclical credits, re-opening sectors, and selected convertible debt. Still, macro and technical suggest in 2022 the wind remains against bond investors, so a selective and active approach to long and a strong ability to hedge will be key performance differentiators in the market.

Russia-NATO – Cold wind on the talks.
This week, Russia and NATO held security talks in light of the Ukraine crisis. The talks were mostly inconclusive, as the objectives of the two sides are still far. Russia is asking for an explicit veto on NATO membership among Eastern European members, while US and NATO are clearly not ready to grant it. On Thursday, public statements among the two sides turned harsher. Russian foreign minister suggested talks may be on hold and its US counterpart responded clarifying that Russia demands can’t be matched. More explicit distance among the two sides increases risks of an escalation and a US response via economic sanctions. Markets responded pricing in concrete chances of military action, with a strong spike in Ukraine risk premia and the Russian ruble falling back to lows despite strong oil prices. Post escalation, risks of a military incident are higher. On the positive side, Russia still has to see the draft of the NATO security proposal, due next week, after which talks may resume. Geopolitical tail risk has thus increased as a result of the event, but markets risk premia in the region have been increasing very fast, leaving some room for positive surprises shall talks resume.