IS THE PAIN OVER?

Weekly Credit Review 31.10-04.11

Last week bond bulls finally experienced some joy after 12 consecutive down weeks. A dream move for the trend follower. I think we can all easily agree that we are primed for a short-term bounce off the lows. I would go a step further and argue that we will see a sustained lift from the bottom, although I admit we can touch the lows one more time.

What I am confident in is the very high likelihood we hold the lows. In fact I had decided to put my money where my mouth is and bought 3 bonds last week for a longer term swing trade (see in CURRENT POSITIONS) which I would use for yield and short calls against. Kind of like doing a covered call strategy. I had outlined in the previous weekly credit reviews the change in tone of FED members communicating with the market and how they shifted from higher for longer to pausing at 4.5% - 5%. This week I am seeing more factors pointing to the direction of reduced bond volatility, meaning bonds going up. The MOVE index had a weekly close lower and the CDX IG and HY indices both made substantial moves to the downside.

Unfortunately, CDX CDS indices cannot show the full extend of lack of fear in the market as they suffer from the roll over effect which has kept them artificially higher. If we look at the CDX IG and CDX HY total return charts you will find yourself (as I found myself) very surprised to see them above the Aug’22 highs, the exact same highs which were seen before the ‘famous’ Powell Jackson Hole speech.

Given all the positive signals we are seeing in the bond market I would argue that expecting a similar move to the downside from the current levels is wishful thinking and shorting right now is the riskier trade.

CURRENT TRADES:

1. Long HSBC 7.39 28s bond. I got allocated the bond and plan to hold it for a few months. I view this A- rated bond as a great investment and worth holding for the long term if you are not a trader. My main thesis in this trade is that you don’t see often an A- banking bond yielding 7.30%ish and it offers a higher yield than other comparable bonds. As a reference, Barclays just issued new 4 year (7.325%) and 6 years (7.385%) bonds at slightly lower coupons but with the MINOR difference that Barclays’ bonds are rated BBB.

   

2. ENIIM 7.3 27s bond. This bond is A- rated from an Italian energy company still staying at the lows and with expected up move in treasuries I think we can try for the 110 handle in a month or so. Energy sector, especially refining are having the days of their lives with high profit margins. I doubt it gets called or tendered as this could have happened when rates were significantly lower. It does not make economic sense to call the bond and re-finance it at higher rates. Nevertheless if it gets called I will still get a premium to my paid price.

   

3. SOAF 7.3% 52s. This one is high yield emerging markets bond. I am trading this bond for the short-term for quick capital appreciation. Having this in mind, should we see a re-test of the lows in the long-end bonds (TLT , ZB_F, UB_F) I will pick this one around 74-75 level. This bond was recommended in last week’s credit review and could have been purchased at the 75 level.

   

   

   POTENTIAL TRADES:

   I will refrain from entering new trades before the FED on Wednesday as I bought the exposure I wanted. What I will focus on now is hedging my portfolio from the volatility on Tuesday by shorting ZF_F (5 year treasury futures) calls if we get another rally in bonds. If we see a sell off reaching the lows and potentially going lower I will sell ZF_F futures to hedge my portfolio.

RISKS:

• Euro CPI Flash Estimate y/y - Do we finally see lower CPI in Europe based on the lower energy prices we’ve been seeing lately across the continent?

• Major risk for the week is obviously the Fed Funds Rate. Will Powell confirm the rest of the FED members view that a ‘pause’ is required at the 4.5%-5% range?

• Unemployment rate on Friday will give us further information on the state of the labor market in the US.

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CONCLUSION:

Given the FOMC statement this week I am going to use any weakness to add more bond exposure to my portfolio. I am leaning bullish and don’t expect to see a breakout in bond yields. If for any reason this happens I will short bond futures contracts to hedge my long exposure. I am happy with picking up 7+% yields in this environment and will position my portfolio for that.