Fed – Hawkish talk, dovish action
The Federal Reserve maintained policy rates unchanged at 5-5.25% at its June meeting, for the first time since March 2022. The dovish action was matched with hawkish talk. The Fed revised up its growth projection for 2023 from 0.6% to 1%, while unemployment was revised down to 4.1% from 4.6% previously. Inflation was slightly revised upward. Importantly, the Fed dot plots, the central bank forecast about its own action, where revised up by 50bp to 5.6% at year end. We see the Fed attitude less hawkish than forecasts suggest. Rates market reacted to the US banking stress pricing deep cuts back in April and the central bank wants to avoid the same playbook. Short term rates price a lower terminal rate than the dots suggest, pointing to some skepticism on the Fed tone. We see scope for the Fed to deliver less than implied by June forecasts.
ECB – Inflation worries
The European Central Bank hiked policy rates 25bp at June meeting and delivered hawkish forecasts too.
Core inflation for 2023 was revised up 50bp to 5.1%, and growth was just marginally revised down to 0.9% for this year. The press conference suggests a July hike is now a given, with some chances of further hikes down the line. The depo rate will then end up in the 3.75-4% range. Overall, we think the ECB action is echoing the Fed. Another 25bp is a given but Ms Lagarde refused to commit for more. This suggests the ECB wants to avoid the market to price a dovish pivot but conviction of further action is low. European inflation is now running at 6%, with core at 5.3%, vs highs closer to 11% in October. We see the ECB as well relatively close to the end of the cycle and see further pullbacks in Euro duration as an opportunity.
AT1s – Market reopening
After three long months of inactivity started with the collapse of SVB and Credit Suisse, the European AT1 market reopened last Tuesday with a €1bn deal by BBVA. The bank came to refinance the upcoming call of its €5.875% AT1 that is due in September. Demand for the deal was strong, at over €3bn at one point, giving BBVA to set the coupon at €8.375% resulting in a spread of 550bps, tighter than that of the AT1 due for call. Whilst not leaving much in terms of new issue premium for investors, the deal was a success for the asset class and proof that, notwithstanding recent events, the AT1 market is very much alive and attractive.
Aside of BBVA, Bank of Cyprus was also able to issue a small AT1 last week in a deal to replace the existing bond due for call early next year. While BBVA’s was more significant to us being focused on the larger, higher quality names, this deal too was relevant as the strong books (c.€2.75bn on a print of €220m) on such higher beta name were testament to the high demand for these products. The deals also prove that issuers remain pragmatic on their approach to AT1 calls and should lead market to re-think extension risk as priced today. With the market now open and c. €7bn left in additional calls through year-end, we expect other major European banks to come with deals in the next months. Therefore, as we look at an average yield-to-call of c.10% across our AT1 holdings, we remain positive on the asset class as it keeps offering in our view a superior risk-reward, in absolute and compared to the wider fixed-income space.
Algebris Investments’ Global Credit Team
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