7 August 2023
Multi-Asset Credit Strategy Monthly Comment - July 2023
Credit spreads closed the month tighter amid speculation that the global monetary tightening cycle is reaching its conclusion. From a macroeconomic point of view, last month saw the prospects of an economic slowdown strengthen. With a few exceptions, leading indicators are falling, with the manufacturing component often sinking into very negative territory. However, in the USA in particular, the persistent gloom in the leading indicators from the various surveys contrasts with the resilience of the economy. The pace of job creation remains favourable just about everywhere, defying the prospects of recession anticipated by the financial markets.
Faced with this environment, central bankers have maintained a restrictive monetary policy stance in their communications and by raising key rates. The Federal Reserve, in line with expectations, hiked interest rates by 25bp at its July meeting, bringing Fed funds to 5.25-5.50%. The FOMC did not pre-commit to any future decision but leaves policy data-dependent, continuing with a meeting-by-meeting approach. Chair Powell recognised policy is getting tight, with credit and economic survey showing a more marked impact on the economy. We continue to see further downside to US core inflation, expecting below 4% by year end. We see the July hike as likely the last in this cycle. Markets now price some chances of another hike by November and some cuts starting in Q2 2024.
The ECB tone at the July meeting came across less hawkish than expected. The central bank hiked the depo rate by 25bp to 3.75%, as widely anticipated, but refused to guide explicitly for another hike in September. Lagarde’s comments signalled more comfort on inflation, but pointed to more work to be done potentially, depending on incoming data. The tightening bias and the very hawkish tone that permeated the past three meetings was considerably smoothed, suggesting we are approaching a more mature phase of the hiking cycle. We see chances of a last hike to 4% in September but think the ECB will stop then.
During the month, the strategy posted a positive performance with all asset classes posting positive performances and financials significantly outperforming the rest of the market. The portfolio continues to be cautiously positioned as we maintain a portion of our P&L hedged to mitigate against potential volatility coming from an unexpected negative macro surprise. The portfolio managers have reduced the levels of liquidity after seeking relative opportunities both in the primary and secondary markets. Valuation remains very compelling across most risk assets and selected themes in credit are still interesting particularly in Europe. We expressed this view mostly via selected defensive BB rated credits and Tier 1 financials. We continue to think that BBB CLO tranches, yielding 7-8%, are an extremely attractive opportunity in the current market context. There were very few new issues to consider as some high quality names tapped to the primary market offering nice premiums versus secondary. The portfolio managers conducted relative value switches from a bottom-up perspective.
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