There were a few things that caught my attention last week...
The US mid-term elections weren’t as bad as projected for the Democrats. Nevertheless, the legislative and executive arms will be at loggerheads for the next two years. The Russian army withdrew to the east side of the Dnieper River, leaving Kherson back in Ukrainian hands, even if a settlement of hostilities still looks a long way off. China seems to be relaxing some of its Covid rules, although restrictions remain draconian by western standards. Cop27 kicked off, but without the leaders of China, India and Russia, some of the world’s biggest polluters. In the UK there was a flurry of strike ballot results which suggests a period of upcoming unrest, particularly in the public sector, just as the Chancellor is preparing us for some real spending cuts. In financial markets, crypto currencies grabbed the US headlines, with FXT filing for bankruptcy. I had no idea who Sam Bankman-Fried was before last week. But he seems to have lost his £30bn fortune despite having a great name.
The big economic news was US inflation. Core inflation retreated to 6.3% and investors were cheered by signs of disinflationary trends. Used vehicles, clothing, household furnishings and IT goods all saw month-on-month price falls. In addition, a change in methodology for the calculation of health costs resulted in a steep decline being registered for October, with the trend expected to persist through 2023. Let’s not go overboard; headline Consumer Price Index is still at 7.7% and the labour market remains robust. I think markets are premature in looking for the ‘pivot’ to a more dovish Federal Reserve policy. This is apparently a minority view, given the strong rally we saw in both equity and bond prices post the announcement.
In the UK, data showed that GDP fell -0.2% in Q3. This was better than expected and reflected upwards revisions for July and August GDP. However, there was evidence of weakening in September, even considering the impact of the extra bank holiday and business closures around the time of the Queen’s funeral. Consumer spending fell, mitigated by government spending and export growth. However, business investment contracted, consistent with weak survey measures of investment intentions. Overall, this does little to change my view that global economies, including the UK, are in for a tough period.
Bond markets were generally strong last week with 10-year treasury yields moving below 4% and the UK equivalent touching 3.35%. These moves were broadly matched by changes in real yields and implied inflation did not change much. Intra-day volatility however, remained elevated with significant daily moves in yields – both up and down.
Credit markets were again buffeted by this volatility. But there was an interesting development: bond buybacks. Sterling credit market investors have, for some time, been anticipating the impact of quantitative tightening (QT – the Bank of England selling bonds back into the market). What was not expected was the rash of sterling bond tenders we saw last week. Glaxo, Just Group, Tesco, GE and HSBC all announced bond buybacks. And you can see why, given the widening in credit spreads and the move up in government yields. If a corporate has cash, it is an effective way of achieving a better return. Conversely, if it is good from the company’s viewpoint it may not be so attractive for the potential seller (i.e., our clients). We did not find the levels on Tesco Property or Just Group attractive and are happy to hold. On a similar theme, there was an early redemption of a social housing bond. The issuer has proposed a buying level of a government bond yield plus 25bps, an acceptable level for RLAM clients and again demonstrating the importance of strong covenant protections.
It is worth looking at the case of HSBC in a bit more detail. Their motivation was not wholly price driven. Regulatory pressures mean that subordinated debt issued from operating entities is discouraged. In consequence, banks are buying back these instruments and offering new debt from their holding company structures. Let’s look at one of the tendered bonds: HSBC 5.375% 2033, which was issued in 2003 at par. The yield on this bond fell to below 5% during 2006 but jumped during the Great Financial Crisis (GFC) – hitting a high of 7.75% in April 2009. In the bond rally following the GFC the yield declined to 2% by 2020. The tender yield is around 6%; a real roller coaster ride over a near 20-year period. So, what is the attraction of selling such a bond back to the issuer at a credit spread wider than when it was issued beyond the premium, compared with its recent trading levels? Well, the new bond that has been issued from the HSBC holding company structure is offering an 8.201% coupon. Fair enough, it is not quite the same structure, but it offers very attractive compensation for the higher risk.
Commiserations to England’s rugby players but congratulations to the T20 cricket team. From defeat by Ireland to becoming world champions shows the ups and downs of sport, and life in general. But before Buttler and Stokes there were Butler and Stokes, who chronicled and analysed post-war British General Elections. David Butler who popularised the swingometer died last week. I can only vaguely recall attending one seminar he gave, but what is clear is that the old voting patterns don’t hold. The social class certainties I learned about as an undergraduate have long gone. Educational attainment and age are now key determinants of how people vote.
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