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Credit Matters

More Treats than Tricks

October 2022


Market sentiment improved in October, from a negative September, despite the persistence of this year’s main narratives: rates continued to rise and inflation remained high in both Europe and the US. Yet, a risk-on mode dominated the
month, backed by unrealised recession fears and protracted hopes of a central bank dovish pivot. Despite weakening manufacturing and housing data, the US economy returned to growth in the third quarter, after shrinking in the first half of the year, while consumer health remained strong. Unemployment fell to the lowest level since man landed on the moon. In Europe, warm weather – and the subsequent lower gas prices –, and improving supply bottlenecks added to the optimism.

Risk rallied: Credit spreads tightened; commodities, leveraged loans and bitcoin gained, while the Italian-German sovereign spread narrowed. High Yield (HY) outperformed rate-sensitive Investment Grade (IG) in both Europe and the US, as longer duration assets suffered from “jumbo” 75 basis point (bps) interest rate hikes. Debt securities with long maturities plunged: US Treasuries +25 years, for instance, fell almost 7%, taking their 2022 loss to 36%, the worst since records began in 1992.

Equities surged, with the S&P 500 adding 8.1%, reducing its year to-date loss to 19%. Gains, however, were mitigated by a Technology sell-off towards the end of the month, triggered by disappointing earnings from Amazon.com Inc., Google parent Alphabet Inc. and Microsoft Corp. Large US Tech companies generate more than half of their revenues abroad, making them more vulnerable to a strong dollar, to a global slowdown and to rising US-China tensions.

After four consecutive monthly gains, the US dollar gave up some of this year’s double-digit gains, dragged down by lower interest rate differentials with other countries and by a worsening Current Account deficit – of 3.9% of GDP, the widest since 2009. The US yield curve remained inverted.  UK assets partially recovered following the appointment of fiscally prudent Rishi Sunak as prime minister; he replaced Liz Truss after her planned mini-budget caused market turmoil. Investors expect further rate hikes in the US and UK this week.


Source: Bloomberg as at 31 October 2022.

Theme of the Month: European CLOs

Rising BBB CLO spreads: strong risk-adjusted returns form IG-rated tranches


In a continuous rising rate environment, we continue to view floating-rate securities as attractive. In particular, we see strong relative value in securities backed by diversified loan pools – an instrument known as Collateralised Loan Obligations, or CLOs.

Rising As seen in the chart above, spreads on European BBB rated CLOs have widened significantly, especially relative to the US, offering an attractive entry point.

Their sharp move in October was triggered by the fiscally expansive mini-budget that the UK unveiled in late September, and which raised questions about Britain’s creditworthiness. The resulting spike in gilt yields led to some leveraged pension funds receiving margin calls on their Liability Driven Investment (LDI) strategies, which forced them to sell liquid assets to meet the cash requirements. CLOs suffered from this deleveraging; the graph below, shows how weekly
public secondary market auction volumes through 2022 spiked following the September 23 mini-budget. A few weeks later, the increased CLO supply in secondary markets continues to be absorbed, given the wider spread levels. Also, total-return investors that historically focused on more junior, subordinated tranches have moved up the capital structure to take advantage of the
opportunity in IG-rated tranches. With prices in the 80s, and yields approaching 10%, these investors have been attracted to the total return opportunity in IG-rated bonds with robust structural protection.

As global rates continue to rise and inflation bites, the opportunity provided by income generating, floating-rate assets remains attractive.

European CLOs: demand absorbs increased supply

Euro CLO BWIC volume (by week, 2022)

Euro CLO BWIC volume.jpg

Source: CQS, CitiVelocity as at 24 October 2022. Auction volumes are expressed through a process known as BWICs (Bids Wanted in Competition).