Wag the dog

With CLOs the thermometer reading is hot, hot, hot. On $20.6bn of CLO issuance, according to 9fin data, this is the strongest start ever. There are strong technical and relative value factors driving this, particularly at the top of the capital stack.

Primary market triple-As have come in to the 150bps area, and some CLOs have printed inside that (Oak Hill in the US and KKR in Europe both hitting 148bps), so it’s natural to see some compression between managers. Second tier managers in the pipeline are expected to come in the 160-170bps region.

But even for top tier CLOs, relative value suggests you’re getting a good level. That’s because longer-dated secondary market triple-A is generically around the 135bps mark, and shorter-dated paper is maybe 115bps — curiously, for double-B tranches it’s primary trading 125-150bps inside secondary, so this is very much a top-of-the stack thing.

Much of this is undepinned by a big theme across the CLO universe — the sheer number of deals entering paydown. It’s only becoming harder for deals failing weighted average life (WAL) and other tests to avoid that. According to Bank of America research, the Q1 primary CLO glut measures up against $12bn of amortisation and $4bn of deal calls so far — on top of an estimated $13bn in paydowns last quarter. But there’s no doubt demand is building up on all fronts, with CLO ETFs having drawn over $1bn of inflows so far in 2024.

JP Morgan strategists have termed amortising CLOs to be an ‘immovable force’, and project 49% will begin to do so by the end of 2024, with 57% by the end of 2025. Indeed, such is the extent of this phenomenon that JPM warns it may eclipse supply by next year — bringing about a “Great Deleveraging” in the sector.

Since CLOs are such a massive engine of leveraged loan and high yield bond markets, that is a phenomenon to bear in mind down the line...

So far in 2024 though, it’s harder to know whether it’s the dog wagging the tail or the tail wagging the dog. Or which is which these days.

Loan repricings and refinancings have been the other massive component of the market — again by all accounts, January was the busiest month ever globally and second busiest in Europe (after March 2017), which is hardly surprising after the strength of the rally in credit over recent months.

The average price of single-B loans is two points higher than the start of December, trading sources note, and if the trend of loan repricings extends it will impact CLOs with a high percentage of loans at 98 or above — especially those out of reinvestment periods.

The loan repricing surge has left CLOs in catch up. One consequence is the reappearance of dealyed draw single-B tranches in Europe, as reported on by 9fin last week. These were a common feature of Euro CLOs in 2023, when spreads were too wide in that part of the cap stack for managers to price single-Bs.

But managers are leaping on the opportunity to draw down on them now, with five having already resurfaced — enough of a trend that it took centre stage in a new CLO notices reporting piece my structured credit colleagues have started.

As Deutsche Bank noted in latest research, the discount margin of 825bps on Contego XI’s delayed tranche was the tightest on this rating since February 2021. But Bridgepoint has since come inside that at 800bps DM.

We are thus talking about structural changes coming to the CLO market, with the single-B class growing in market share.

Teflon teacup

Given credit spreads are back to new tights for the year (iTraxx Crossover closing at 309bps on Monday) and stock indices back on the ascendency (the S&P 500 hitting a new high of 5,030), it’s strange to think a mini tantrum gripped markets just a week ago.

The tantrum came about from the US Consumer Price Index having the cheek to come in slightly higher in January than economists had forecast. A fairly tumultuous few hours ensued across various asset classes for the rest of the Tuesday 13 February session.

Crossover widened 7bps to 321bps, but much bigger moves were afoot in US stocks and government bonds. The 10-year US Treasury jumped 13.5bps wider to 4.31%, while the Russell 2000 stock index slumped nearly 4.5% at one stage, to 1,953, ending the day still down 4% on it’s worst session since June 2022.

It’s curious to see the 10-year UST has hardly retreated from that move, at 4.3%, while credit and stocks have made a strong resurgence. Investors appear to have taken diminishing Fed rate cut expectations in their stride and carried on. The reality, I suspect, is that there is simply too much demand and high hope still coursing through the market, given the recent momentum, for anything to put a sensible check on it for long.

That thesis faces arguably an even sterner test tomorrow (21 February) after the US closing bell, when Nvidia — the most magnificent of the “Magnificent Seven” tech companies — is set to report Q4 earnings. Analysts have projected an astounding $2bn rise in revenues from Q3, to $20.5bn and before a slight retreat today its stock was up over 50% since the start of the year.

The following session, Thursday, is also when global flash Purchasing Managers’ Index numbers come out. But while PMIs could boost or drag on momentum if Nvidia scores, I doubt they will help the mood at all if Nvidia misses. Things could get rocky again around then.

World of worry

With everyone so fixated on buying into buoyant credit markets, there’s not a huge amount of attention span out there for anything beyond the central banks and tech. But it feels quite likely one of the following will very soon take over as another dominant narrative in 2024 — the US election, another US regional banking and real estate crisis (with New York Community Bancorp having been the pre-rumble), China imploding or resurging, the Middle East conflict spiralling into something much bigger, or… Russia re-entering the picture as the west's public enemy number one.

There was a hell of a lot for western leaders to catch up on when they met to discuss Russia at the Munich Security Conference over the weekend. It’s as if the Israel offensive has created a vacuum of Russia media attention of late, and until the past week Russia played into that by keeping a low profile. Suddenly though, there are a number of reasons to believe more is going on behind the scenes and that once again Vladimir Putin is extending his reach into the public consciousness. In the death of Alexei Navalny, yet another political opponent — and some would say the last hope for democracy — has exited the picture, adding to a long line of mysterious denouements including Boris Nemtsov in 2015 and Yevgeny Prigozhin as recently as August. Just today it was reported that a defected Russian pilot, Maxim Kuzminov, was shot dead in Spain by assailants unknown.

The spectacle of Putin’s interview earlier this month with Tucker Carlson, in which he painted western countries as the aggressors and more or less blamed the Ukraine war on Boris Johnson, contained far too many references to Poland for my liking. His insistence that he has no ambitions to invade Poland unless it attacks first only raises a question of whether Russia will seek to provoke that possibility.

It is probably too early to get hysterical about a recent Bild report — questioned here by Newsweek — that Russia has an eight-point plan to annex a strip of Poland connecting Kaliningrad with Belarus. But Dmitry Medvedev’s threat to nuke the UK, US, Germany and Ukraine if Russia loses occupied territories also somewhat undermined Putin’s message on the Carlson interview that he is looking for reconciliation.

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