I’ve been down with some kind of lurgy, hence this week’s Macro Prophet is out today (Wednesday) rather than Monday. But the extra days have given me a chance to see the final push of CLO managers to complete deals before the August slowdown. And it’s given Fitch the opportunity to feature here by having bestowed a surprise downgrade on the US, cutting its AAA credit rating to AA+. Though not of the same shock factor as S&P’s downgrade 12 years ago (also in August), this rattled the US Treasury curve and has prompted a weaker opening to markets this morning.

Are you still sure August will be boring?

One thing to look out for after the break is our forthcoming service, 9fin Structured Credit — launching soon to cover the CLO market. Content from this new service is currently available as a preview to all 9fin Premium subscribers, but will soon require a subscription to 9fin Structured Credit to view. For more info on this product and the accompanying database, contact subscriptions@9fin.com

Always something left to love

Common to the macroeconomic and CLO components is that headline numbers may look great, but there’s a lot under the hood that maybe gets overlooked. For those who haven’t followed the previous nine instalments of Macro Prophet, that’s been the seam I’ve looked to mine.

I’ll dig deeper on economic numbers next week — when presumably there will be less to say about CLOs — but let’s start with the positives. Here a picture says a thousand words, and Deutsche Bank’s chart of the week shows how good a month July was for risk assets.

A lot has been said about the improvement in European and US credit market levels. For an excellent appraisal of what this means in the leveraged finance market, please see my colleague Chris Haffenden’s Friday Workout. Some caution has returned this week, and following the US downgrade Crossover is out 5bps to 392.5bps, according to IHS Markit, but we’re still a long way improved from the start of July.

But let’s talk about the sentiment shift in Chinese credit around the July Politburo meeting. I pointed to that as being a key event to watch, and so it turned out. Perhaps a ‘big bazooka’ was lacking, but government statements indicated some important policy shifts. There was no mention of suppressing property speculation, as had been trumpeted in previous meetings, which many have been taken to mean it is switching from price control mode to stimulus. That’s timely given reported issues with property developer China Country Garden, which is seeking a bailout.

Similarly with local governments, the language has evolved from “strict control of hidden debts” to the need to “optimise local debt structure”, suggesting they will have more scope to refinance and restructure.

For China, “maintaining the stability of the capital market operation” has become “stimulate the capital market and improve investors’ confidence”. As I wrote about before, it’s that lack of confidence that has been particularly damaging to the country’s economy this year after a strong first couple of months. New measures such as tax relief as well as support for state-owned enterprises and key industries may help that cause.

This is the reading among credit market professionals looking at Chinese company debt. Since the start of last week, a near 16bps rally in the iTraxx Asia Ex-Japan index took it to 95bps on Monday this week. This was its tightest print of the year, improving on the 97.25bps it hit on 3 February when confidence was high that China would have a good 2023. It has come in from a peak of 153bps on 20 March.

Another remarkable run of recent days has been for one of the more pressured emerging market economies. Turkey’s five-year CDS rallied over 50bps last week, taking it to 388bps — its tightest level since September 2021. This was despite new central bank governor Hafize Gaye Erkan revising up the country’s year-end inflation projectionto 58%, from just 22% in the previous estimate.

Back in Europe, a lot of positivity appears to have been taken from the IMF projection that Germany will suffer the G7’s only contraction in 2023. While in the US, there’s almost as much giddiness about Barbeheimer having grossed over $1bn in first showings and the Federal Reserve Bank of Philadelphia having referred to Taylor Swift’s boost for the economy.

Of course, the real giddiness in financial markets stems from a belief that US and European central banks are nearing a tipping point in fighting inflation. The Fed is nearing the end of its hiking cycle and ECB messaging has shifted from avowed hawkishness to ‘maybe’ when it comes to a September policy rise. The market is quite divided over whether the Bank of England will extend its rate by 25bps on Thursday, to 5.25%.

Waking up their souls

But what of the country least amused by the deluge of Barbenheimer memes? Japan notably now has higher inflation than the US, and its central bank actions last week show it is entering the global picture as a newly active — and hard to read — participant. After seemingly leaking misleading pre-announcement guidance to media, the Bank of Japan unexpectedly changed its yield curve control policy (analysis here from ING), signalling in effect that it is taking back control of that and will do so in a deliberately disruptive way that keeps markets guessing.

This may be read that Japan itself believes that other central banks are largely done on their own aggressive moves, as it has been long speculated by economists and pundits that the Bank of Japan was playing a wait-and-see approach with its global peers. But regardless, the key takeaway is there is a new source of potential volatility, and that we are moving away from central bank policy divergence to a path of convergence.

Flowers falling from the sky

Amid all the prevailing optimism, it may seem churlish to keep arguing that more difficult times lie ahead. That remains my thesis though, and there are plenty of macroeconomic signals to support the view. One might be to compare and contrast improving precious metals this year (gold up from $1,823 an ounce to $1,954) with the slump and lack of recovery in the S&P GSCI Industrial Metals Index.

A starker picture emerges when looking at global purchasing manager indexes, which I’ve argued are more of a leading indicator the consumer price indexes.

Global PMIs are looking far from healthy. They are looking historically parched in fact. Apart from India, someone should be out with their watering can.

I chose One Hundred Years of Solitude, one of my all-time favourite novels, as the literary theme for this week’s column, by dint of its relevance both to market cycles and the idea of price discovery in a returning market with few data points. Yes, we’re onto the part about CLOs…

In the book, the town of Macondo grows from a tiny settlement cut off from society — possibly an island, supposes archetypal character Jose Arcadio Buendia — to become a large, bustling centre of industry. This begins with the arrival of a train line and establishment of a banana plantation / corporation. In the end it’s these incursions of the outside world that lead to Macondo’s downfall, terminating in a huge windstorm that wipes the place from the map.

But that’s getting too far ahead of ourselves. A striking facet of the story — and frequent cause of complaint among detractors — is that the many characters have a baffling similarity of names, compounded by how some seemingly disappear for large swathes of the narrative, or even die, and then reappear once again in central roles.

But anyway, CLOs…

Learned alchemists

There’s no more foolhardy venture for a journalist to undertake than try to compare and contrast different CLOs as they come to market. Managers tend to be very precious about every basis point, particularly at the top end.

Yet, given the dearth of CLOs this year in the European market, particularly over recent months, last week I set out to do just that. It has always been a tricky exercise with lots of factors to consider. But the subsequent feedback I received taught me that there are a whole new set worth thinking about in the current landscape. Also that these are even harder to quantify since there is a wide range of approaches between managers and arrangers about which factors they are keen to reveal.

At the risk of further annoying everyone, here are a few of my observations.

It’s generally accepted, and I bow to the point, that the first manager to set a new pricing benchmark deserves some extra credit. Subsequent transactions may improve on this, but one should expect a degree of tightening as price discovery firms up. In this, I’m reminded of General Moncada from the novel:

“He succeeded in having Macondo raised to the status of a municipality and he was therefore its first mayor, and he created an atmosphere of confidence that made people think of the war as an absurd nightmare of the past.”

We must also allow other surface factors, like that a static CLO in the manner of Palmer Square European Loan Funding 2023-2 tends to price 15-30bps inside non-static. Furthermore, you have to be clear about the term structure of a deal — is it the standard five-year reinvestment, two-year non-call, or are we looking at some variation?

But in today’s market, it is not enough to look at the deals from Bain, Polus and Investcorp and determine that their very similar looking triple A prints, based off similar five/two formats, are in fact the same. And it’s even more perilous if you delve down the capital structure and make statements about overall cost of debt — and I’m not even talking about the schoolboy error of weighing coupons against discount margins. This goes much deeper.

First of all, not all deals publish their tranche attachment points, so you may be comparing triple As with 38%, 39% or 39.5% par subordination. Whether they have a six-week or eight-week price to call also appears to affect the price, though I wouldn’t be brave enough to say to what tune. And let’s not forget if CLOs have relied on heavy anchors to get their deals away.

But at the bottom of the stack is where manager lines blur most, given the economics of wider prevailing spreads versus the underlying assets. These days you may not have a way of knowing whether the single Bs and double Bs are retained, partially retained, or placed.

This raises big questions over whether we should be comparing CLO cost of debt at all. Suggestions welcome on this — should it be just a comparison of the tranches above double B? Or should one publish two calculations, one with and one without these tranches included?

I’m sure there’s a lot more considerations I’m forgetting to include here. As my colleague Owen Sanderson rightly pointed out in Excess Spread last week, we maybe should also be looking at CLO heavy exposure to the large wobbly B3 structures.

Of course, it would help no end if CLO managers could avail all the relevant information so we don’t make unfair comparisons. But take that suggestion as you will.

Everything written on them was unrepeatable

Naturally, any ground established by the recent spate of CLOs is liable to be swept away forthwith in any case, since market context could be entirely different when the pipeline cranks back up in September. So we can have the fun of going through the price discovery all over again.

One part of the recent issuance flurry we could see carry over to September is CLO refinancing. Elmwood Asset Management’s partial refi this week was the first in over a year, but it may well be followed by other managers that priced deals when prevailing spreads were wider. Elmwood is different to many other CLOs in following a three/one structure, and those that have another year or two to reinvest are more likely to reset than refi. Either way, they would be a welcome addition to overall market volume if new issuance remains sparse.

Anyway, I hope this helps reader confidence that 9fin will try it’s best to keep in mind this myriad of perspectives as we map out the future CLO market because, as Gabriel Garcia Marquez points out, “One minute of reconciliation is worth more than a whole life of friendship”.