The good news: things feel finely poised going into September. There have been no disasters for bonds or loans during the August lull, and conditions are ripe for issuance as borrowers look to catch-up on refinancings.

The bad news: things feel finely poised going into September. Recent market moves have not changed my view that the ‘as good as it gets’ moment for credit spreads this year has passed — around 28 July to be precise. 

On the face of things, last week exhibited overall robustness in US / European credit and stock indices, although with signs of resistance in both despite strong company earnings and little to provoke alarm (or interest) out of Fed Chair Jerome Powell’s Jackson Hole speech on Friday.

The lack of excitement in Powell’s higher-for-longer mantra got me thinking about a very cautionary, if fantastical tale. Clive Barker’s The Hellhound Heart (aka Hellraiser in the film version) is apposite reading for those yearning for more out of life. In today’s fantastical credit landscape there are several fronts on which events could soon get a lot more interesting, and reinforce the saying that you should be careful what you wish for.

Cured of excess

It’s probably time to re-evaluate what’s happening with the AI boost to stock markets and how much more we can expect of that. Nvidia Corp provided a moment of discomfort for tech bulls last week, through no fault of its own. Having reported $10.3bn in data centre revenue, with 171% year-on-year growth, it sailed past already sky-high second quarter estimates and gave even more optimistic guidance for Q3. 

Some analysts see it achieving a near monopoly on graphics processing units and have enthusiastically upped their Nvidia share price targets. But having briefly rallied above $500, the company’s stock subsequently slipped back to $453.5, and hasn’t gained much ground since.

This leaves some questions: what if it has hit its yearly peak, or at least a big resistance point, and that was more realistically around the $475 level it reached back on 18 July. What if that logic holds true for the rest of the tech/AI sector? And the perennial, but well-founded concern: what if we are looking at the new Dotcom blowout, and indeed a run of performance like Cisco exhibited back in 1999/2000? There are strong arguments that this time it’s different, but the market’s reaction to Nvidia’s stellar results shows the company cannot afford to put a step wrong if it doesn’t want to be the new Cisco kid. The line between pleasure and pain could be very sharp.

In that vein, Broadcom’s Q3 earnings results this Thursday will be one to watch for avidly.

Walking with demons

The overarching narrative is much deeper though. The main conundrum is how the US can proceed increasingly out of step with what’s happening elsewhere in the world — and how long it takes Europe to realise following the US lead on key policy decisions is a flawed plan.

While the Fed sits resolute at the ship’s bridge, maintaining its throttle on fighting inflation, the US enjoys low unemployment, a resilient housing market and decent growth. There are cracks being overlooked, such as PMI readings and the six-month fall in the temporary help services sector, a leading indicator for the jobs market. The rise of 30-year mortgage rates also poses a problem for the future, while commercial property markets are another lasting headache.

But overall it’s full speed ahead for the US, no suggestion of applying the brakes. Elsewhere there are alarming signs the titanic is sinking. Within the G20, Saudi Arabia has joined Germany in recession, which has got to be a wake up call. Oil prices are kept close to $80 a barrel, so it might be assumed things are rosy for oil producers. This clearly isn’t the case, as to maintain price pressure they have had to cut output. And the reason they’re cutting is because demand — ie economic growth — is faltering.

Problems with the world’s second largest engine of growth, China, are well documented by 9fin. There has been some resurgence of Chinese credit and stocks in recent sessions,  but the crisis in its real estate sector remains the dominant narrative. And with Chinese exports and imports in a slump, there is little reason for optimism on its impact for commodity prices and production.

Italy also registered negative GDP growth at its last reading, meaning it could be in technical recession at the next. The UK lies on the cusp of negative territory, having recorded minimal growth for some time. Outside the G20, the Netherlands has also slipped into technical recession.

As my colleagues like to say, two is a trend. And we’re well beyond two.

Opening door

There are two hypothetic scenarios in which credit and stock indices (in the US at least) manage to keep stable while the ground shifts. Either there is market-wide resistance at current levels, led by index trading, or there is some rebalancing as cyclical credits recover some ground as higher rates hit sectors that are sensitive to longer duration. I don’t see a scenario where spreads take another triumphant move tighter, unless some major new pump is discovered to put the global economy back above water.

Without having anything too concrete or compelling to go on, US credit has felt a bit stronger than Europe of late, which is not what many credit analysts had been predicting. The things they’d expected to give maybe just haven’t yet given, but there’s enough uncertainty re-entering the picture for the CDX HY index to have undergone a near-symmetrical -17bps / +15bps seesaw Wednesday and Thursday last week.

Still, the contorted balance has bought everyone more time. High yield borrowers would do well to feature in the September pipeline, particularly if they have maturities to refinance over the coming year. My colleagues Ryan Daniel and Alessandro Albano delved into European primary dynamics last week here and here. And in the US, Sasha Padbidri and Bill Weisbrod looked forward to a busy month for bonds, loans and private credit.

Unfortunately, investors aren’t quite as enthused for high yield bonds as commentators might claim, or as borrowers might hope. High yield funds recorded their seventh outflow in a row last week, although the pace of exits has slowed, noted Bank of America in Friday research. Geographically, this was across the board but European outflows were the worst.

There were small outflows from HY ETF funds as well, for the fourth week in a row. Of broader concern is that high grade funds suffered their biggest outflow in 22 weeks, although that was largely accounted for by one big fund. The shift from longer duration investment to short term appetite is apparent in outflows from one and inflows into the other, while the extending flows into government bonds speaks volumes for how investors view the relative value proposition.

Borrowers must at least have taken some comfort from the CLO market keeping a good pace. Including resets, there have been almost 30 US CLO primary market transactions in August. Even Europe, which was expected to be dead, has mustered four new CLOs.

More than that, the secondary CLO market has remained abuzz, with bank desks reporting healthy two-way trade across the capital stack, although sub-investment grade tranche flow was lighter last week and mainly driven by equity rather than mezz. Buysiders were also slightly more inclined to sell positions.

Latest research from Barclays, published today (Tuesday) suggests primary market CLO triple-A tranches look about 30bps attractive to secondary levels, which have rallied around 45bps this year to around 161bps. Weighted average primary among longer duration deal have ranged between 172bps and 210bps, bringing the generic level to around 191bps. 

The higher-for-longer narrative supports CLOs, says Barclays. This seems to support the idea that CLO resets could pick up, which would in turn be a boon for high yield borrowers looking to A&E — although as I argued last week, there are reasons to be skeptical that a big wave of these will happen. 

The flip-side to this primary / secondary CLO divide though is that secondary markets might need to give. Which would be another pleasure-to-pain reversal of quite sizeable proportions. 

For anyone banking on the CLO magic box doing its trick for challenged high yield credits, it might be pertinent to keep in mind the words of warmth uttered by Barker’s demonic Cenobites:

“No tears please. It’s a waste of good suffering.”