29.09.17

Snapshots has been filing expenses for our recent US road trip and still can’t believe we were charged $9 for a black coffee in Austin!

Inflation and Slack

That is just an anecdote which in itself has no meaning but we note that some economists are calling the recent disinflation transitory, particularly in the US where a large component was caused by a wireless price war. Oil prices are also starting to pick up again (albeit from low levels). With oil supply having been cut by OPEC and global GDP strong this is no surprise.

Output gaps are also falling sharply, eliminating slack in the developed market economies. These economies are also near full employment. Note that this is not the case for Europe.

Deficits and Hawks

At the same time, the political agenda is moving towards higher deficits at least in the short term. POTUS Trump’s tax plan does this via tax cuts. Theresa May, or whoever wrestles her for control, will come under public pressure to address PROTUK* heir Jeremy Corbyn’s anti-austerity and public spending manifesto. In Japan, Shinzo Abe has called snap elections so he can focus on public spending rather than addressing the country’s bloated fiscal position.

Central bankers will be watching these developments closely and although they can’t make political comments, they will be fine tuning their econometric models. We expect them to stay on their current hawkish trajectory.

So what?

What does this mean for the credit markets? The most obvious read across is for leveraged corporates. Current high levels of debt are being supported by comfortable debt service ratios, which themselves are a function of two factors: low interest rates and accommodative capital market access. This will not always be the case. It is no surprise that our Leveraged Finance team are throwing credit memos for companies that don’t have a clear deleveraging path over the next two years straight in the bin!

The other obvious read across is that interest rate sensitive sectors like banks should continue to perform well. At the other end, Telecoms and Utilities could come under pressure. We highlight again that Telecoms have been massive consumers of credit in this cycle to fund expansionary Capex and M&A as they build out new business models that involve content, bundling and 5G. They should be monitored closely.

Issuance

September was a strong month for issuance as the capital markets restarted after the summer lull. The Postal Savings Bank of China launched the world’s largest AT1 shrugging off any concerns of China’s recent sovereign downgrade. There are a number of charts currently circulating around the street showing that on a risk-adjusted basis (i.e. for duration and rating) we are hitting world record for issuance. Not surprisingly, the credit metrics of some of these issuers is causing lively debates on our trading floor.

*PROTUK – Prime Minister Of The United Kingdom – You heard that first at Cairn Capital!

By Asif Godall
Co-Chief Investment Officer