Maybe Too Fast.

A short note on the recent market movements and economic data. At the end of October I called on two possible trends, that are in a certain way connected: the possible peak on long interest rates in US and Europe and the opportunity to open a long position on the EURUSD cross below parity. I also explained the reason why, in my opinion, the negative trading position (hoping on a widening gap) on the Italian BTPs against Bund in 10Y was conceptually wrong and most of all, not correctly timed. The CPI reports in the US and then in Europe, the recent speech of the Fed Chairman Jerome Powell, some news coming from China, accelerated the trends in an unexpected strength, taking many portfolio managers by surprise. Volatility remains very high and intraday movements very wide.

The 10y US Treasury yield dropped by more than 70 bps. EURUSD made more than 5 figures up, BTPs continued their march well inside 200 bps against the German bonds (some hedge funds have been stopped around this level).

In credit markets, November continued the rally which started at the end of October when the markets started to enjoy a macro bounce and felt encouraged by the positive Q3 earnings of some credit names. The iTraxx Crossover index tightened by more than 100 bps. I have noticed many buyers in IG and HY names with all sorts of investors lured by the possibility of booking high single digit returns and even yields in the low tens. There have been many types of players active in the credit space in November: they appeared initially in AT1s and then moved their interests into other sectors and rating spectrums like Bs and BBs. Strong credit sessions followed bullish days of trading. It seems the credit players enjoyed (finally) the stability provided by the world of government bonds. This is especially true in Europe.

What lies ahead for the next weeks? What are the dangers and points to watch????????????????????????

1. Rates have been excessively compressed on the downside and I struggle to see 10Y US Treasury and Bund at current low levels. Italy 10Y at 3,7% does not make sense if we consider a terminal rate in Europe at 2,75%/3% and a possible QT at the end of Q1 (the spread against BUND should head north in January). Regarding the US, markets are continuing to anticipate the Fed and to suggest possible monetary actions before the Central Bank makes up its mind. It is a dangerous bet and Chairman Powell has been misinterpreted last week in my point of view (or was he too relaxed?). A downshift does not mean a pivot but I am not alone in claiming this truth.
2. EURUSD has rallied, although this upward movement came mainly from dollar weakness more than a change in narrative from the Old Continent. The area of 1.05/1.06 was a clear target when the cross remained well sustained above 1.02/1.0250. China events have been a positive factor for the euro. Many shorts against EURO have been cleared (almost all of them) and this new trading range 1,0450/1.06 is the new starting point for many traders. I still predict 2023 will be a bearish market for the USD but the EURO needs more stamina for continuing its march upwards in the near term. I suggest buying EURO on dips or corrections but be aware of profit taking and data surprises. Considerations on rate differential between Europe and US are less important in the current context; options levels with strikes, volumes, positions, market sentiment will be more important over the next weeks. There are interesting analysis and research on the USD seasonality behaviour in December and January. I don’t read too much into them because they don’t consider what the last two years have been for the USD currency and how traders positioned themselves for many months after months in 2021 and mainly 2022 (I still hear the predictions of 0,95 or lower).
3. The Credit market has rallied in November and some HY bonds are up 8/10 figures in 30 days. It seems overdone and there are good shorts available at these levels. Credit selection is paramount and while certain paper is still cheap (financials and some credits that will be refinanced) many sectors are definitely expensive because they are overleveraged and with poor earnings perspectives. Broad-based gains mask the problems of some names which rally together with the market (but they don’t deserve merit). 2023 will be the year of credit surprises (did you hear about Blackstone Real Estate Investment Trust?).

Author:?Sergio Grasso, Director at?iason

Previous Market Views available?here