Activity in the quiet season

The high yield primary (HY) bond market has been historically weak in recent months but is expected to recover in September.

As the period of seasonal calm settles in, let’s take a look at last week’s earnings, economic data and central bank moves.

Following a string of negative reports on US retail earnings and prospects, Walmart beat expectations after cutting its guidance just three weeks ago. The company sees a shift toward groceries away from electronics, home and sporting goods as the lower-end consumer focuses on essentials. Target largely missed earnings expectations as the retailer aggressively cut prices to shed excess inventory of discretionary products. Despite this setback, the company said it continues to see a healthy US consumer. The US housing market continues to show signs of slowing as Home Depot saw a decline in customer transactions due to higher mortgage rates and higher materials and labor prices. Cisco, the largest maker of computer networking equipment for the Internet and enterprise, surprised with more upbeat comments as signs of a shortage of chip offerings fade amid steady demand. On Friday, August 19, 2022, Deere & Co. lowered its full-year guidance due to cost pressures and manufacturing inefficiencies related to the supply chain.

Earlier in the week, China set a negative tone as retail sales, industrial production and investment activity slowed and missed July estimates amid property market weakness and the COVID lockdown. Goldman Sachs now expects China’s GDP growth to be just 3% this year, well below the 5.5% target set by the government in March. In the United States, homebuilder sentiment fell for the eighth straight month, the worst trend since 2007, with home sales falling 26% since January to the slowest pace since May 2020 — the biggest six-month decline on record. Housing starts fell well short of expectations. Despite a general drop in sales, inventories remain tight and prices are rising across the country. Empire Manufacturing (a survey of New York state manufacturers) was weak compared to expectations, posting the second-largest decline after April 2020 since data began in 2001, with sharp declines in orders and shipments reflecting a sharp drop in demand in the indicate region.

On the plus side, industrial production beat estimates, particularly auto production, with semiconductor supply shortages showing some signs of easing. Retail sales in July were little changed, with declines in gasoline prices and car sales, but better results in other categories. On Thursday, August 18, 2022, the Philadelphia Fed Index rose against an expected decline while initial jobless claims fell for the first time in three weeks, which we believe indicates a continued resilient labor market in the United States. In the UK, inflation rose more than expected, hitting a 40-year high in July, which we think will prompt the Bank of England to act. Expectations appear to be closing in on a 50 basis point increase in September, 25 basis points in November and 25 basis points in December, with a decline in Q4 23.

Then we look at central bank moves for the week, led by surprise rate cuts from China and Turkey, despite Turkey facing inflation at a 24-year high. In the US, minutes from the latest Fed meeting point to a more neutral to slightly dovish shift from recent comments and raised concerns that policy could overtake tightening. But not everyone agrees. On August 18, 2022, St. Louis Fed President James Bullard expressed a more aggressive stance in favor of a 75 basis point rate hike at the September meeting, saying the downward pressure would be additional and crucial to inflation. The next major Fed event will be August 25-27, 2022 during the Jackson Hole retreat, where historically news can increase market volatility at a time when market liquidity is generally low.

Charts of the week: supply update and outlook for US IG, US HY and US leveraged loans

In the investment grade (IG) space, supply increased sharply in August, particularly in the non-financial sector (left chart). With $108 billion printed to date, this month is already among the busiest August on record, and September is also expected to be above average (right chart below).

Primary high yield (HY) bonds have been historically weak in recent months, but are likely to pick up in September (left chart) on the back of ample LBO/M&A funding. Resuming issuance could penalize secondary spreads. The resumption of issuance could have a negative impact on secondary spreads, but we note the improvement in the price of new HY issuance, a sign of better demand (right chart below).

As with high yield, leveraged loan supply was low over the summer but is also likely to pick up in September given the pipeline of leveraged finance acquisitions (left chart) . Technical demand for credit has been relatively stable and the CLO formation should remain strong over the next month (right panel).

Source: Credit Suisse, Credit Suisse Strategy Daily Supply Update, August 17, 2022. For illustration purposes only.

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