Thankful for the short opportunities
Weekly credit review - 11.28-12.02
As expected, last week was one of the slowest weeks this year, however slow does not always translate into less opportunities. With the already extended credit markets, the non-eventful week led to slow and steady grind upward in the credit markets which further squeezed higher the already sky high corporate and EM credit. At current prices, I am certainly not a buyer, rather I sold 95% of our long portfolio on Wednesday and Friday. The other 5%? I simply couldn’t get good enough bids on Friday as the liquidity was very thin, else I would have sold 100% of our long portfolio.
A few trades we did last week:
WHAT ARE THE CHARTS TELLING US:
Fed Funds Futures still pointing to 5% terminal in the spring/summer period in 2023. I would have thought a few weeks ago that we will drop to 4.5% but this didn’t happen. If the FED FUNDs market is telling 5% , then it is 5% (for now). Treasuries , especially the long-end seem overextended. This is the reason for the large inversions we saw last week.
2. I would be interested in shorting US bonds (long yields) when we reach the yellow lines. They point at the exact previous June’23 highs.
3. CDX High yield index being close to the 450 level may cool off the lack of fear in the market.
I would certainly hold off any speculative longs for the time being. US and EUR markets seems extended and prone to a correction. I don’t think we test the yearly highs in yields or in the CDS indices but I believe a 2-3 weeks correction can ensue before we resume the year-end window dressing. Timing is key to successful trading. Now is not the time to go long credit. At least the risk to reward is not there to substantiate a reasonable long trade.
CURRENT PORTFOLIO:
Long g-spread in REPHUN 34s at 240
Long g-spread in ROMANI 31s at 256
Short outright SOAF 7.3 52s at 88.50
95% out of long positions.
POTENTIAL POSITIONS:
COSTAR 5.625% 43s
BAHRAIN 5.625% 31s - courtesy of @em_credit_fund
RISKS:
The risk events this week are overwhelming. ECB president Lagarde, Fed Chair Powell, Euro CPI, Unemployment numbers , you name it.
Each risk is an argument to avoid getting long credit at these extended levels.
Even if we have lower numbers which may point to lower rates, I am beginning to think the markets will switch to a recession narrative which will result in wider credit spreads. When the equity markets drop, bond traders avoid paying for cash bonds.
CONCLUSION:
As a professional I am obliged to seek for the best risk to reward trades the market is currently presenting us. I am not be right about my short positions and they may lose money but I strongly believe that I have less risk to the upside now than to the downside, hence my risk to reward ratio is skewed in my favor. Why do I think so?:
CDX High Yield very close to Aug’22 lows while rates are not close to the Aug’22 lows
Credit spreads on many cash bonds narrowed to levels seen last in Aug’22
Bond Yields 2Y, 5Y and 10Y are between 100 to 150bps higher than the Aug’22 lows.
I can never be sure as to the next move but I can position myself to the path of least resistance. For the credit markets to keep further tightening we would need to see further drops in CDX , while simultaneously the equity and bond markets should continue their march higher. For that to happen we need to see a lower terminal rate. For the time being this is not happening and terminal in the States is sitting at 5%. I am of the opinion that bonds moved so much to the upside that even if terminal moves down to 4.5% they will still not move much because they had essentially front-run a potential shift lower in terminal rates. On top of it, portfolio managers are marking up their positions, a strategy known as window dressing.
