Europe – Inflation data pave the way for the hawks.
May inflation data have surprised on the upside last week, paving the way for bolder action by the ECB over summer. Eurozone-level data came in at 8.1% for May, above the previous record of 7.4% and consensus expectations of 7.8%. The print was mostly driven by second order effects from energy price hikes, as service inflation is actually moderating, or growing less. Germany and Italy saw the most worrying inflation trends, against some sign of moderation in France and Spain. European data also show early signs of rising wage pressures: the ECB’s negotiated wage indicators rose to 2.8% for Q122, up from 1.6% in Q421. Hawkish rhetoric from ECB speakers have picked up meaningfully over the past month, and May data mean decently bold action must now follow. The failure of inflation peak make more likely to see a 50bp hike at the July meeting, and makes the June meeting this week a good opportunity to guide markets toward that. We think it is plausible for the ECB to end up the year with rates at 1%.
Credit – Take a look, but keep it IG.
May started with a deep selloff but ended with a rally, as some stability in US Treasuries brought a large drop in volatility, and with it strength in credit and equities. The strong month-end rally was triggered by the combination of stretched short positioning and some positive data point on growth out of the US and China. We believe credit may have more room for strength. Spreads have somewhat tightened, but remain at levels consistent with a sharp downturn. Credit funds have built up cash buffers to hedge against the risk of outflows, and new issuance stays anemic given higher funding costs. More positive growth data points or a further reduction in volatility will thus have easy time pushing some cash into credit markets, further supporting the segment. We see more value in IG or high grade credit, as spreads are surely misaligned vs plausible default rates and rates stability benefit the segment the most. We see any rally as tactical here, as long-term rates remain underpriced so fixed income markets will remain vulnerable over the next twelve months.
Algebris Investments’ Global Credit Team
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