During the week ending September 9, 2022, risky assets began to retrace the declines initiated after the Fed Chairman’s speech in Jackson Hole. Equities closed higher and high yield credit outperformed investment grade credit. Sentiment improved as the US dollar weakened against all G10 currencies except the Japanese yen. Energy prices continued to fall, driven by rising US crude oil inventories and falling market expectations on demand, China is only expected to grow twice slower than the average of the last five years. Even OPEC+’s announcement to cut production by 100,000 barrels per day next month had little impact on energy prices. It was almost as if investors had decided that all the bad news was already priced in, the worst fears were coming true, and no new information could make the situation worse. So the market went to buy!
Central banks have clearly reignited fears of a rate hike: the Reserve Bank of Australia (RBA) raised rates by 50 bps, while the Bank of China (BOC) and the European Central Bank (ECB) raised them. 75bp readings; all accompanied their interest rate decisions with hawkish rhetoric. However, as their respective currencies have appreciated against the US dollar, one could interpret that the central banks of the G10 are regaining confidence. In our view, they are applying the right policies to bring inflation back in line with medium-term price stability objectives. Consensus now calls for the FOMC to raise interest rates by 75bp at its September meeting.
Then, energy supply fears took center stage when Gazprom (contrary to expectations) cut off gas supply from the Nord Stream 1 pipeline after three days of maintenance due to an oil leak. . However, the market quickly concluded that since the European Union met its gas storage targets two months ahead of schedule, a gas supply disruption this winter is unlikely (unless the winter is exceptionally cold and there are supply problems in Norway). Muzinich’s proprietary model draws the same conclusion (see the “Chart of the weekIn our baseline scenario of an average winter, with no non-Russian supply disruptions, no Russian flows, with a 10% reduction in demand and no return of production from the Groningen field, inventories will fall to 13% of capacity.The key question will be how to replenish stocks next year.At the end of the week, electricity prices in Germany were similar to those of the previous Friday, before Gazprom’s announcement .
Finally, China has seen no respite, with its zero Covid policy remaining unwavering. Chengdu city has remained in lockdown and the government is advising citizens to minimize travel on National Day next week. The positive effect of this policy is that it is not inflationary. This week, inflation data from China showed slowing consumer and producer price growth. We think this gives the authorities more leeway to stimulate the economy without fear of inflation problems.
Risky assets are now showing signs that they are moving within a trading range. It seems that the bad news is out, and the situation has cleared up. As nothing is pushing prices lower, a retracement has been initiated. Still, the issues identified are far from resolved, limiting the upside to previous highs. It could now be that we remain in a range for the rest of 2022, without a new uptrend or downtrend emerging. In this scenario, we believe that carry strategies could offer attractive returns while investors wait.
Charts of the week: Level of gas storage in the European Union from January 2018 to June 2023 according to 3 scenarios
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Positive scenario: Average winter, no disruption of non-Russian supply, maintenance of Russian flows via Ukraine, 10% reduction in demand, return of production from the Groningen field.
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Baseline scenario: Average winter, no non-Russian supply disruption, no Russian flows, 10% reduction in demand, no return of production from the Groningen field.
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Negative scenario: Cold winter, no non-Russian supply disruptions, no Russian flows, demand reduction by 10%, Groningen field production does not return.
Source : Muzinich & Co.: Muzinich & Co. proprietary model, September 6, 2022. For illustrative purposes only.
Spread to Worst & Yield to Worst as of September 9, 2022:
Source : ICE Index Platform, as of September 9, 2022, Muzinich’s views and opinions are for illustrative purposes only and should not be construed as investment advice. The indices selected are for regional comparison purposes, determined by Muzinich as follows: ICE BofA Euro Corporate Index (ER00), ICE BofA Euro High Yield Constrained Index (HEC0), ICE BofA US Corporate Index (C0A0), ICE BofA US Cash Pay High Yield Constrained Index (JUC0), ICE BofA High Grade Emerging Markets Corporate Plus Index (EMIB), ICE BofA High Yield Emerging Markets Corporate Plus Index (EMHB).
Warren Hyland, Emerging Markets Portfolio Manager at Muzinich.
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