Uncategorized
Conserving liquidity
admin | October 25, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Across most parts of credit, the value of liquidity seems to be rising. Less liquid investment grade debt has widened to more liquid. Lower-rated CLO debt has widened to higher-rated. ‘B+’ and lower rated loans have widened to ‘BB’ and better rated. And the Fed keeps pouring liquidity into the repo market and the broader financial system, but market rates on fed funds continue to exceed IOER. The market seems to be conserving its liquidity.
Liquidity looks likely to get more valuable at least through the end of the year. Seasonal reductions in trading volume and bank balance sheets should drive up liquidity value, especially since G-SIB capital buffers depend on average and ending balances in the fourth quarter. Drawing down repo activity is one of the easiest ways for G-SIBs to reduce total balance sheet and lower the risk of a higher surcharge.
The Fed’s program of overnight and term repo along with its aggressive purchases of Treasury bills is starting to address the liquidity risk, but seeing fed funds still running above IOER suggests continuing friction in moving cash around the system. Although understanding of these frictions continues to improve, the diagnosis is not complete. It is fair to assume that concerns about liquidity requirements and balance sheet size will slow banks’ ability to pass liquidity into the market efficiently.
Investors sensitive to mark-to-market or anticipating significant need for cash in the fourth quarter have good reason to migrate into the more liquid parts of their preferred markets. Most spread products should keep widening into December. Irregular issuers should widen to regular issuers, smaller issues to larger, complex products to simpler.
For investors with access to cash, the market is starting to offer opportunity. Less liquid but fundamentally good cash flows are widening to more liquid. The work needed to re-underwrite the risk in these cash flows should pay off.
Liquidity often rebounds in the first quarter as banks scale balance sheets back up and other investors consequently have an easier time and incur lower costs for rebalancing portfolios. The cumulative effect of Fed repo and reserve injections stands to make the liquidity pick-up in early 202 especially sharp. Investors able to weather a few months of relative illiquidity can harvest likely gains in the New Year.
* * *
The view in rates
The Fed looks almost certain to cut another 25 bp on October 30 and bring its mid-course correction to a temporary end. The telling part of the upcoming FOMC will likely be in the monetary policy outlook. Rates in the front end of the curve look likely to be pinned down, but the long end of the curve should be sensitive to the Fed view of growth and inflation, including the influences from a slowing global economy.
The view in spreads
Except for the leveraged loan and CLO markets, investment grade and high yield credit continue to tighten. Leveraged loan funds continue to see outflows while high yield funds generally see inflows. Even though less liquid components of each market should widen to more liquid, the liquid parts of credit still have some room to tighten. MBS has lagged credit and should continue to trade at soft spreads largely due to heavy volumes of refinanced loans flowing through the market. MBS spreads should stay soft through the balance of the year and start to tighten thereafter.
The view in credit
Slowing global growth will almost certainly catch the most leveraged credits, and spreads in leverage loans reflect some of that concern. Leverage in investment grade corporate credit also has trended up this year. As for the US consumer, low unemployment, high income and high aggregate household wealth leave consumer balance sheets in good shape. The readiness of the Fed, the ECB and other central banks to backstop growth makes broad recession unlikely. The weakest credits should feel a slowing economy, but without recession, the averages should remain good.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
