But in dismissing the film "Everything Everywhere All At Once” as utter nonsense, Reid is plain wrong. He asked people to tell him this, so I’m telling him (and also that he’s right about most other things). The irony is the film so strongly resonates with a financial landscape in which protagonists are wont to dream of something much better just around the corner, while the current reality is a litany of failures in a washed up global landscape with a Jamie Lee Curtis-like nemesis about to exact the toll.

It’s unfortunate Jim only watched half the film. I watched it twice last year. Maybe I just had more time on my hands.

Anyway, “come with me and live up to your ultimate potential, or lie here and live with the consequences…”

From the film

The universe is so much bigger than you realise

It’s been my contention in recent editions of Macro Prophet that far-reaching problems are stacking up in the global economy, but are glossed over in the general analysis. More than ever focus is skewed towards US numbers and policy, with even Europe taking a back seat.

This is understandable, as it sits well with investors to be long in credit and stocks while they are convinced the Federal Reserve will pause rate hikes, and as oil prices rise and the dollar strengthens. These things shouldn’t go together — after all, higher oil and gas prices means higher August CPI, and any ECB hawkishness that results from this should mean a stronger euro — but don’t let that stop the buzz.

WTI crude oil has recovered from its dip. Source: oilprice.com

Softening US job numbers also shouldn’t be cause for bullishness, but has been — as my colleagues noted in the European Levfin wrap on Friday. Nevertheless, whatever stops the Fed feels like a friend. I fear though that too many investors have been sucked into thinking this broad rally is sustainable, despite credit spreads being already back at the year’s tights. Or, if you’re a loan index, hitting the highs. 

Morningstar LSTA US Leveraged Loan 100 Index, via S&P

Meanwhile, not nearly enough is being done to spot early stage problems — as a lack of China commentary showed before August. There’s a lack of credit picking, a lack of targeted hedges, very little concern for the winter ahead, and no-one is looking to left-field (more on this below).

One matter that definitely isn’t getting a look in is the latest coup to hit Africa, in Gabon. So much so it probably feels strange even to read about it outside emerging market commentary. But these developments shine a light on a growing trend that is worth identifying. It also underscores that there is a high level of idiosyncratic risk emanating from the margins, although the headline numbers for important commodity markets like oil look quite robust.

This also got me thinking about the theme of dispersion — or lack of it — in core credit markets. I’ll re-examine that through the lens of CDS trading — something else that has lacked examination even though synthetic volumes have been strong and there’s the small matter of CDX and iTraxx index rolls coming up this month. A couple of credit event questions are looming: both of which may seem immaterial, but do serve as reminders that defaults are a bigger consideration for incoming index series and structured credit portfolios than appears the case right now.

There’s less to say this week on CLOs because, well, there’s been a bit less trading. But the tightness of latest deal pricings adds conviction to CLO reset optimists and sits out of step with broader macroeconomic concerns.

A Brand New Man

Gabon’s military last week decided the country’s election, which returned President Ali Bongo to power, was a fix. Bongo’s rule has been questioned since he suffered a stroke in October 2018 — after which his convalescence precipitated a previous (failed) coup in January 2019. But this time he has been put under house arrest and the military has installed General Brice Oligui Nguema as transitional leader.

Gabon joins five other African countries — Burkina Faso, Guinea, Mali, Niger and Sudan — to have undergone coups in the last three years. To outsiders this may feel par for the course on a continent where there have been over 200 coups since 1950, of which around half were successful. But Gabon has been ruled by the Bongos since 1967 — Ali’s presidency stems from 2009, having succeeded his father Omar when the former leader’s death closed a term of over 40 years.

There are wide repercussions of anti-colonialist ferment in Africa. France in particular finds itself losing further purchase on west Africa after being kicked out of Mali and Burkina Faso. It is easy to see a domino effect to other countries in the region such as Cameroon and Senegal.

For non-EM investors, Gabon is still relevant as an affront to the picture of well-supported commodity markets — which Saudi Arabia falling into recession should already have brought into question. Gabon is an OPEC oil producer, with exports having been projected to cover up to 40% of this year’s budget. The elevated price of crude belies that producers have had to cut their quotas due to slowing global demand. Gabon is also the world’s second biggest producer of manganese, behind South Africa, and mined 4.6m metric tons last year. The coup may pose problems for the steel industry, which accounts for 90% of manganese use.

One big western investment firm immediately impacted by the coup is Carlyle, which had agreed to sell its holding of Gabon petroleum company Assala to France’s Maurel & Prom for $730m. That transaction, which had been slated to conclude in Q4 23 or Q1 24, included the roll-over of Assala’s $600m RBL facility, with an upsize of M&P’s existing bank debt facility ($183m) and a one-year acquisition facility (up to $750m) secured with the support of M&P’s controlling shareholder Pertamina.

“The transaction still remains subject to various approvals,” said M&P, “including from the Republic of Gabon and CEMAC (Communauté Economique et Monétaire de l'Afrique Centrale) merger control clearance.”

Neither Carlyle or M&P will have taken much confidence from US and French reactions to the coup, nor from how Gabon sovereign bonds have tanked in its aftermath.

They might well hope Bongo, a cherished friend of the west, can be allowed to prove his fitness for office once more with a rendition of this belter.

Failure to disperse

Just a few months back there was not too much talk of credit spreads improving, and a lot about how dispersion at the wide end of the market was inevitable.

Going into September, a delve below the bonnet doesn’t find much evidence of credit picking — at least from the CDS side.

Credit indices have rallied on conjecture about an end to Fed hiking, an ECB pause this month, and growing hopes of a soft landing. 

via IHS Markit / S&P

Alongside this, iTraxx and CDX equity tranches have also been rallying more often than not over the past year.

CDX HY first loss 0-15% tranche (points up front), via IHS Markit / S&P

Arguably this is not a huge relative value play against the broader improving outlook. But implied correlation — the measure which tends to rise inversely to the cost of equity tranche hedging — has generally been on the rise, or flattish across portfolios. Only in high yield indices has there been a fall in equity tranche correlation, and that is quite minor. In investment grade indices like CDX IG below, there has been a slight rise.

via IHS Markit / S&P

Some credit investors did wisely deduce months back that this would be a year for beta investment rather than striving for alpha. But the action in equity tranches feels symptomatic of a lack of single name fundamental credit work. Instead the vast bulk of credit trading has been in directional plays or hedging through the index, and of late there has not been a huge amount of appetite to hedge relative to those looking to get long on the optimistic vibes.

This is odd given what is happening at a single name level. Within the iTraxx Crossover there are 13 constituents now quoted in points up front by IHS Markit — a recognition that they are in difficult territory. Within US high yield index CDX HY there are 30 in this more risky category.

Altice has hit the news of late, but another 42 Crossover and HY names are quoted in PUF

Illiquidity is clearly hampering single name CDS trading across the high yield universe. There are 25 names in Crossover alone that IHS Markit assigns a liquidity score of five (meaning deeply illiquid), with eight at the next worse liquidity rating of four.

Things are slightly better in CDX HY, with only Frontier Communications, PG&E, Sabre Holdings and Universal Health Services on a score of five. But another 22 names in the index have a score of four. Arguably, some like Universal Health Services may be less traded in the HY context because they have become more like IG names, but there’s also little happening at the Frontier or on the edge of the Sabre, which are pretty wide (around 800bps and 23 PUF, respectively).

In conclusion: there is massive scope for a run of defaults in Crossover and HY. But there is also not a lot of willingness to trade in large swathes of either portfolio.

Rock ‘n’ roll

For people looking ahead to this month’s roll to new CDS indices (20 September for IG, Europe and Crossover, 27 September for CDX HY) perhaps the most surprising thing will be that there are no defaulted credits to replace.

That could change as Casino Guichard-Perrachon is under consideration as a credit event question at the EMEA Credit Derivatives Determinations Committee — for something like the ninth time this year. Looking at the Casino curve though, bets are diminishing that it will default in the next three months.

Casino CDS curve, via IHS Markit

It would be a curious inclusion in a new Crossover index series though, with almost certainty in the bets beyond three months that a default is on the way, and that it’s just a question of when.

There is no let up to the challenges at the DC about it having triggered a failure to pay credit event — with a meeting scheduled this Thursday to discuss the latest. For us journalists an interesting facet is that the DC, in rejecting the previous attempt, expressly argued that the claim needed two media sources to support it — whereupon these were found in the latest question to the DC, meaning the claimants feel there’s a chance that this will be enough to tip the decision in their favour.

Beyond the illiquidity issues hampering high yield index constituents, and the rare credit improvement story, there’s not too much to merit changes to the HY and Crossover portfolios in lieu of actual defaults. There’s little sign of constituents being elevated to the IG universe.

Speaking of which, within iTraxx Europe one missing credit that will have to be replaced is Credit Suisse. Looking at the other European banks with enough size to merit a spot in the financials basket, is it time for a DZ Bank, KBC or Erste Group to step in? These do trade in CDS, although are very illiquid, with scores of five, four and four, respectively.

This could be a roll to consider fallen angels, which raises the consideration that liquidity could bring changes to the high yield portfolios if any IG names need to drop down a league.

The implied ratings of iTraxx Europe constituents does suggest a few changes could come on that basis. Anglo American, Arcelor Mittal, ELO, Glencore, Hochtief, Lanxess, Stellantis, Unibail Rodam Co Westfield — all have implied double-B ratings with IHS Markit. Actual rating agency actions trail the companies’ CDS performance, however, with even Unibail (the widest of those names at 209bps) still holding IG bond ratings from Fitch, Moody’s and S&P.

Unibail five-year CDS, via IHS Markit

In CDX IG the same can be said of Ally Financial, DXC Tech, Freeport McMoran, General Motors, Lincoln National Corp, MDC Holdings, Paramount Global, Radian Group, Teck Resources, the AES Corp, and Whirlpool.

The widest of those, Ally Financial with five-year CDS at 235bps, is hanging on in the BBB- area at rating agencies.

Liquidity-wise, Unilever in iTraxx Europe has only garnered a score of four (one being best, five worst). And in CDX IG, EIDP has only garnered a score of four while DXC and Ovintiv are three.

Kindness is necessary and strategic

The investment universe in 2023 feels very predicated on short horizons, which is a problem I’ve been trying to explore throughout this column. Maybe the current rally is a form of kindness investors are bestowing on each other into year-end in compensation for the stress of imagined assailants that have failed to materialise. I can get on board with that, if that’s all it is.

China is a case in point. It belatedly came to everyone’s attention last month amid a whole host of economic woes, particularly in real estate and trade. Now investors are happily filing China back in the ‘deal with later’ tray, as a new government mortgage plan sends credit spreads tighter and the Hang Seng index rallies.

Hang Seng stock index

Vanke in the iTraxx Asia Ex-Japan index highlights what’s happened. Last month the company’s CDS blew wider, but felt more like a passenger to the wider problems in Chinese real estate than a contributor. Last week, with government intervention in the sector and the company’s CEO Yu Liang sounding an upbeat message, Vanke CDS rallied back sharply.

Vanke five-year CDS, via IHS Markit / S&P

Real estate problems are not going away just yet though. That should be evidenced by yet another Chinese firm, Sino Ocean Holdings, becoming subject of a credit event question at the DC. There hasn’t actually been a lot of CDS trading on the name — at least, IHS Markit doesn’t track it — but I doubt that it will be the last to hit the DC’s inbox.

Always something to love

Despite my reservations on dispersion and idiosyncratic risk, one has to concede it is good for those looking to construct and place structured credit portfolios. There still hasn’t been much change in the steepness of investment grade CDS curves, which is needed to make synthetic bespoke portfolios more compelling to investors. There has at least been some shift in the US high yield CDS market though, which is a step in the right direction — providing you’re willing to do the fundamental work to pick out the right credits and accept that re-steepening curves also imply more defaults down the line.

CDX HY curve now vs three months ago, via IHS Markit / S&P

Right now though, there’s an improving mood around CLOs. Generic triple-A spreads are improving in the primary market and US deal supply stepped up in August, while remaining decent in Europe. Equity distributions have also stayed robust in both regions, as the underlying basis with rates has stabilised.

There is still a lot to do to get CLO issuance back on track.

The big unknown is what happens with primary market loans and bonds as the market grinds back into gear in September — some thoughts here from ourUS Levfin Wrap. Loan indices, as mentioned, are hitting new highs, and bonds are getting back up there, but a lot could depend on how much arrives in the coming weeks and whether CLOs are able to absorb that.

IHYG ETF — tracking European high yield bonds

“Leveraged finance supply improved in the US but remained subdued in Europe,” wrote Barclays strategists in an August recap note today. “Total bond and loan issuance is running faster, albeit only marginally, than in 2022, driven by an uptick in HY supply.”

The tightening primary CLO spreads lends optimism for resets in the coming months, as we’ve talked about in previous editions of this column. Certainly, Redding Ridge’s deal last week played into that narrative of spread improvement for Europe, but it should be noted (as Bank of America did in research on Monday) that European secondary triple-As widened by 5bps to 170bps. It’s natural to expect there will be give in both sides of the market to bring them back into line — with the ultimate point of gravitational pull deciding how many CLO resets it is reasonable to expect.

“Growth in BSL CLOs outstanding is challenged because of rising prepayments,” said Barclays today. “In the absence of resets, $70-75bn of issuance is required in 2024, or CLO outstanding will start to decline. This is lower than the historical average, but a challenging market environment may make it difficult to achieve.”

Especially if, after all this optimistic imagining about the economy and daring to dream, the Q4 reality check pops up like this:

Still from Everything Everywhere, All At Once