Before we start 2023

In the previous post I have described how expected monetary policies decisions roiled the financial markets in December. The usual market expectations built a momentum in price trends that was not justified by the Central Banks narratives. This has already happened two or three times in the past months. Some areas of the markets have corrected, some not yet. We need more people at work on the desks to see these imbalances reduced and reversed.

In this brief note I want to highlight two important points which are interesting and able to influence the next price actions in some areas:

a) The Bank of Japan’s policy move to expand the band around the 10YJGB target to +/-50bp, from the previous +/-25bp. Recently, there had been an increasing call for normalising monetary policy to address issues surrounding the functioning of the JGB market. This announcement was not completely a surprise because this pre-emptive move facilitated the change in BOJ helm which will happen in April 2023. The new candidate for the Central Bank will continue the current easing framework, but there was the need to anticipate something for supporting the JPY and assuring comfortable financial conditions for the future. The consequences of this policy decision were evident in the forex market and equity. USDJPY is now around 133.10 after falling from 150 at the end of October. What is not still clear is how this decision is going to influence the yields in the other government bond markets: US and Europe. The technical adjustment in the yield curve control programme from Japan will likely impact the other EGB markets and the US Treasuries, either through sheer correlation or through actual flows. A liquidation from Japanese investors of foreign holdings is a real threat for yields in Europe and US. This is an important force that should attract the attention. (Is it just an unfortunate circumstance the fact that US curve flattened by roughly 30 points since the beginning of December, led by the long end where the 10Y has severely underperformed?)

b) The CLO market in Europe has managed to survive in 2022 with the help of financial engineering and banks participation in the upper part of the capital stack. The financial initiative from banks and managers has supported the market and consequently the leverage loans prices. They should be trading 4-5 figures lower than current levels but the demand from the different vehicles (ramping up new portfolios and managing the existing ones in reinvestment period) has kept a floor for the loan prices. Entering in 2023 it is important to observe a big dispersion across existing CLOs: tier 1 and tier 2 managers, management styles, performances, structures with different reinvestment and all periods, old vehicles approaching the end of the reinvestment period and many already outside that CCC buckets and JR OC cushions seem ok at this moment but the dispersion across the vehicles is forecasting different and wide performance of the notes over the next quarters. The CLO market is resilient and will bear the volatility; the investors in the capital stack should however start already changing the gear for driving uphill. With greater reason, a macro analysis and a bottom-up approach are two priorities for investing in CLOs and make a profit from it. The homogeneity of the CLO market, especially in Europe, has finished with the COVID at the end of Q1 2020. Now, some years later, it is compelling to discern the absolute and relative value of the different investment possibilities. Not everything is good or has the same risk/return profile.