Market Views

GLOBAL CREDIT BULLETS | Tuesday, 19th April 2022

ECB – Behind the curve.
The ECB meeting last Thursday came out more dovish than expected. Updates on the policy front were minor. The APP program will terminate in 3Q (though no exact timeline provided), and the first hike will take place only once purchases have ended. The tone, however, sounded less committed to a quick tightening than previously perceived. Worries on the war-induced economic uncertainty have markedly increased, and further policy steps are now explicitly linked to economic momentum in the next quarters. Inflation concerns remain high but are now way more balanced against the economic risks than the March meeting suggested. A July hike is still possible but much less likely, so pricing has moved backward towards the end of the year. Inevitably, the ECB came across as less committed to fight inflation so that EUR weakened, and the bund curve steepened. EUR/USD is now at 5y lows, and Germany 2s10s is at the steepest levels since 2019. With inflation running at 8%, a re-focusing of ECB on the economy or spreads will continue to raise market concerns, especially as the Fed kicked off hikes. We continue to see chances of a recession in Europe as lower than market pricing suggests. More pressure on FX may thus mean hikes will not be postponed by much ultimately, and the ECB may need to shift back to a hawkish tone relatively quickly.

US inflation – Local peak on the horizon.
US CPI inflation for March marked new highs, but also raises hopes that a peak may not be too far. The print was 8.5% on a YoY basis, and 1.2% MoM, hence showing a robust increase. The energy component, however, represented most of the increase monthly, with much of the energy pick-up to fade off in April. In fact, core CPI was up just 0.3% on a MoM basis, lower than consensus for the first time since August, and displaying the slowest monthly pace since October. Used cars, a strong driver of core for the past nine months, are finally dropping, and vehicles and shelter are showing signs of stabilization too. More stable core and a takeback in the energy rally all point to a potential strong moderation of the monthly pace in coming months. Base effects will also help the next print, as recent inflation momentum started in April 2021. Overall, levels will remain elevated, but the latest print suggest more optimism about the peak being reached. Eurozone inflation prints for April will be out this Thursday and may also be informative about the slowdown of the energy component. Overall, we maintain conviction on higher rates over the medium term. A local pause, though, may help a break in the rates rally over the next 2-3 months.

China – Too little, too late.
In China, the economy continues to suffer from intermittent lockdown, but policymakers remain too cautious. Q1 data came out at 4.8% YoY, above consensus but still well below the 5.5% that authorities target for the year. Higher frequency data, however, reveal a more worrying trend. Retail sales for March contracted 3.5%, the first negative print since the 2020 Covid crisis. Jobless rates and housing investments are also exhibiting sharp moves, moving close to levels previously seen in 1Q20. The impact of increasing lockdowns is thus not reflected in quarterly GDP yet, but it’s hitting hard on March data, suggesting the potential for a stronger 2Q22 hit, unless the situation normalizes. Authorities have responded by cutting banks required reserve ratios by 25bp. The policy move is shy, as the RRR for large banks remain above 11% anyways, and lending rates have not been cut. Economic momentum continues to lack in China, and new lockdowns add to the stress caused by the real estate crisis in 3Q21. Still, policymakers have been abstaining from monetary expansion for the past nine months, despite policy room and slow CPI trends. A continuation of this trend will make the 5.5% target for the year harder to reach and may turn a China slowdown as a key market risk for the year.  

France elections – Show time.
On Sunday April 24th, France will hold the second round for Presidential elections. In the first round, incumbent President Macron led far-right Le Pen by almost 5 pp. The surprising result of left candidate Mélenchon, just 2 pp below Le Pen, had been the main surprise of the first round, and his votes will likely determine the outcome of the second round. Mélenchon has spoken publicly against a vote for the far-right, but his base is sensitive to several social issues endorsed by Le Pen. The vote seems thus quite open on Sunday. Since the first round, polls have turned in favour of Macron, with second round polls moving 2 pp higher from 52% to 54% in favour of the incumbent, on average. A Le Pen victory thus seems less likely than feared a few days before the first round but is far from impossible. While her message has strongly toned down on Europe and immigration, compared to two years ago, she is likely to be considered unreliable by markets, and her Presidency would dramatically change the outlook for European leadership, especially with Italian elections next year. OAT and BTP spreads have widened into the first round but tightened right after. European equities and credit are well off the weakest levels of the year and are largely overlooking the event. The second round on Sunday has thus the potential to be a key tail risk for European markets.

Algebris Investments’ Global Credit Team

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