Macro markets

Credit

You might see some “credit not buying the rally” graphs, in the newswires.

Here’s what they are driving at.

Note the high yield (HY) spread, & BBB (investment grade) spreads, which remain elevated, relative to the bounce in equities, over the past few days.

That’s where the sentiment is coming from, and hence why some are more inclined to “sell the rip” than “buy the dip” at present.

In general, spreads remain quite a bit wider than at the November “hawkish pivot”, which is when Powell made it abundantly clear that ultra accommodative conditions would slowly be removed.

As we’ve talked about a lot, the Fed isn’t just tightening policy because growth is good. That’s a part of it, sure, but it is the supply side constraints that are causing inflation to rise that is the primary driver of the desire to tighten.

If it were just “strong growth = higher rates” than spreads would likely not widen, as the implied default rate would also decline.

We continue to see spreads as overly tight, and remain happily underweight credit within our fixed income allocations.

That could easily change, with a 100bp widening from here.

Emerging markets

It’s worth mentioning that are-higher-rates-due-to-higher-growth OR are-higher-rates-due-to-higher-inflation is also a fairly important question for emerging markets, both debt and equity.

Higher growth expectations have positive spill over effects into the EM region, with typically higher currencies, and asset prices, with higher inflation driving the opposite outcome.

The key graph to keep in mind is this one, which highlights the effect of 100 basis point increase in 10−year U.S. Treasury yield on EME asset prices.

Emerging market equity has sold off, in general, and whilst the valuations are very attractive, we’ve resisted the urge to add to the minimal positions we do have.

Emerging market debt hasn’t really sold off at all, and similarly to our points above about credit generally, could be attractive with more generous spreads on offer. For now, however, those spreads are at about pre-pandemic levels, and thus not compelling.

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