1、North America Credit Research21 March 2019 Credit Market Outlook&StrategyUS High Grade Strategy&CDS ResearchUS High Grade Strategy&Credit Derivatives ResearchEric Beinstein AC(1-212)834-Paul Glezer(1-212)270-Pavan D Talreja(1-212)834-Sheila Xie(1-212)834-J.P.Morgan Securities LLCSee page 32 for anal
2、yst certification and important disclosures.J.P.Morgan does and seeks to do business with companies covered in its research reports.As a result,investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.Investors should consider this repo
3、rt as only a single factor in making their investment High Grade StrategyThe Feds dovish surprise is a positive for all risky assets,but the resulting decline in UST yields makes it less of a positive for HG credit.How much of their pivot has been driven by weaker expected growth remains to be seen.
4、We believe HG bond spreads will widen by year-end,driven by less supportive growth,weaker corporate earnings,and increased concerns about corporate leverage.That said,near-term technicals are supportive with bond supply coming in below last year and HG bond fund inflows increasingly strong.Gross sup
5、ply is trending down more than 5%in 1Q with one week to go,and net supply is down about 35%thanks to higher maturities.Mutual fund/ETF flows for HG bond funds in February were strong at$17.7bn.This was the strongest inflow month in over a year.However,demand from overseas investors has slowed recent
6、ly with some profit taking evident recently.BBB short-end bonds are relatively more attractive for spread investors compared to A rated long-end bonds from a risk and return perspective.We upgrade Aviation to Overweight from Neutral.Credit DerivativesCDX.IG and iTraxx indices rolled this week.The CD
7、X.IG Series 32 index roll closed at 7.4bp on Wednesday,which was slightly rich to the roll fair value of 7.8bp.This was about in line with our expectations.CDX.IG options rolled lower in implied volatility but marginally higher in daily spread breakeven.CDX.HY Series 32 rolls on March 27.For the new
8、 HY series,there are seven name changes.We expect the roll to trade about 11bp/6c cheap to the CDX.HY S31 version 3 index.CDX.IG is relatively more skewed toward lower rated names than the broad HG cash market.HG CDS-Bond basis has narrowed recently,driven by the outperformance of BBB rated bonds.Tr
9、ade TrackerSince our last publication,our Trade Tracker is down$188.Over the last 12months,performance is up by$947,940(+4.7%ROI/+24.7%IRR).Chart of the week:HG bond spreads are trading much tighter than a regression with 10yr UST yields implies,but this regression has not been strong recentlySource
10、:J.P.Morgany=-0.40 x+272.26R=0.391201301401501601701801902402502602702802903003103203306m RegressionUST Yield bpJULI Spread bp2North America Credit Research21 March 2019Eric Beinstein(1-212)834- Table of ContentsSummary and Outlook.3The High Grade Week Ahead.14Credit Derivatives.18Trade Tracker.24Hi
11、gh Grade Analytics.25Sector recommendations.25JULI sector statistics and performance.28Credit Derivatives Analytics.29HG CDS-bond basis across buckets.29Previous Featured Articles.30US Economic Calendar.313North America Credit Research21 March 2019Eric Beinstein(1-212)834- Summary and OutlookThe Fed
12、s turn and High Grade bond spreadsgood or bad?The Feds dovish turn this week clearly surprised markets,with UST yields materially lower.A large majority of FOMC participants now expect zero hikes this year,down from a median projection of two hikes in December;this was more dovish than consensus exp
13、ectations.In the statement the Committee was described as being patient in assessing the outlook,and the reference to rate“adjustments”continues to indicate no bias to tighten or ease.The statement noted indicators of slower growth of household spending and included a new observation that headline i
14、nflation has declined,largely as a result of lower energy prices.Finally,there was the expected statement on the balance sheet runoff plans,which were more generally accommodative than anticipated.Balance sheet runoff will end in October,which was in line with expectations,but there will also be a t
15、aper down in the pace of runoff of Treasuries,starting in May when the caps are reduced from$30 billion per month to$15 billion per month.After September,these caps go to zero.In the updated economic projections growth was nudged down a little this yearno surprise given the way Q1 is shaping upwhile
16、 the unemployment rate was revised up 0.1-0.2%-point over the forecast horizon.See Michael Ferolis note for more details(link).When the Fed statement was released UST yields fell sharply,with the 10yr yield 8bp lower on Wednesday.For High Grade spreads this raises a key question of which matters mor
17、ethe negative of lower UST yields or the positive of more supportive monetary policy for all risky assets.Another aspect of this debate is that the Feds turn to a more dovish position,while being discussed in terms a switch to average inflation targeting,is happening at the same time that the econom
18、ic data has softened.The answer to the first question is dependent,partly,on whether the Feds change is one purely of approach or more simply a reaction to the weaker economic data and outlook.In our view,the combination of lower UST yields and weaker growth will be a more important driver of spread
19、s than the more bullish monetary policy stance,over time.There is usually a negative correlation between UST yields and spreadsi.e.,lower UST yields brings wider spreads.Using a rolling three-month regression,this correlation is negative 80%of the time,positive 20%.YTD both UST yields and spreads ar
20、e meaningfully lower(-24bp for spreads,-15bp for UST yields),so we have been in this 20%rangei.e.,positive correlation.Going forward we believe it is likely that lower yields now put some upward pressure on spreads.This is because investors have significant positive returns to take YTD(+4.4%in 10yr
21、HG bonds,+5.0%in 30yr)and because the marginal new investor faces lower potential returns with lower entry yields.4North America Credit Research21 March 2019Eric Beinstein(1-212)834- Exhibit 1:HG bond spreads are trading much tighter than a regression with 10yr UST yields implies,but this regression
22、 has not been strong recently Source:J.P.MorganExhibit 2:The 1m correlation between UST yields and HG bond spreads has turned negativeExhibit 3:The 3m correlation between the 10yr UST Yield and JULI spreads has been positive recentlySource:J.P.MorganRecent economic data continues to be on the weak s
23、ide and portends weaker corporate earnings in the upcoming earnings report.The charts below show several indicators of the growth trend.These include JPMs economic activity surprise index,the Atlantas Fed GDPNow growth index,and JPMs recession risk indicator.Each of these are models using recent dat
24、a releases to gauge broader GDP growth trends and risk,and they all give a similar message of growth weakness.Some data points to a rebound going forward,and JPM continues to call for 1.5%growth in 1Q19 and 2.3%in 2Q,but the trend in our GDP forecasts has been downward revisions recently.Exhibit 4:T
25、he JPM economic activity surprise index has been negative for 23 consecutive days Source:J.P.Morgany=-0.40 x+272.26R=0.391201301401501601701801902402502602702802903003103203306m RegressionUST Yield bpJULI Spread bp(1.00)(0.80)(0.60)(0.40)(0.20)-0.20 0.40 0.60 0.80Jan-18Mar-18May-18Jul-18Sep-18Nov-18
26、Jan-19Mar-191m Correlation Coefficient(1.00)(0.80)(0.60)(0.40)(0.20)-0.20 0.40 0.60Jan-18Mar-18May-18Jul-18Sep-18Nov-18Jan-19Mar-193m Correlation Coefficient-30-20-10010203040Jan-17Apr-17Jul-17Oct-17Jan-18Apr-18Jul-18Oct-18Jan-19JPM Economic Activity Surprise Index5North America Credit Research21 Ma
27、rch 2019Eric Beinstein(1-212)834- Exhibit 5:The Atlanta Fed GDPNow Forecast fell to a two-year low recentlyExhibit 6:The JPM recession indicator model implies a 44%probability of a recession beginning in the next 12 monthsSource:J.P.Morgan,BloombergWe believe these weaker growth trends,continued unc
28、ertainty on trade,along with tight labor markets with rising wage growth increase the risk that corporate earnings in the coming quarters will disappoint.High grade bond markets are focused on significant corporate leverage and the need for many large companies to delever.If earnings trends weaken a
29、nd they threaten these deleveraging plans,this should have a negative impact on spreads.Near term vs longer term,and tighter spreads before wider?Our view is wider spreads by year-end,driven by less supportive growth,weaker corporate earnings,and increased concerns about corporate leverage.However,t
30、hese factors will play out slowly,while market technicals impact spreads more quickly.These technicals are currently supportive,with supply coming in below last year andfund inflows coming in stronger.Through February HG bond supply was down 5%y/y(net supply was down 42%).With seven business days le
31、ft in March MTD supply stands at$81bn.This compares to$109bn in March 2018 and an average of$120bn in March over the past four years.Maturities in 1Q19 total$247bn,up from$223bn in 1Q18.Therefore,gross supply looks set to be down approximately 5%y/y while net supply will likely be down by a greater
32、magnitude.Over the past four years 2Q supply has been 3%lowerthan 1Q,on average($326bn vs$338bn,respectively).This suggests that the positive technical of lower supply will continue.0.0%1.0%2.0%3.0%4.0%5.0%6.0%Jan-17 Apr-17 Jul-17Oct-17 Jan-18 Apr-18 Jul-18Oct-18 Jan-19Atlanta Fed GDPNow Forecast10%
33、20%30%40%50%Jan-17May-17Sep-17Jan-18May-18Sep-18Jan-19Probability of recession beginning in thenext 12 months6North America Credit Research21 March 2019Eric Beinstein(1-212)834- Exhibit 7:With only about a week left in March,we expect the monthly gross issuance for March to be lower y/y Exhibit 8:Hi
34、storically,quarterly gross supply has trended lower each quarter throughout the year.We expect lower supply in 2019Source:J.P.Morgan,DealogicThere is less data on demand,but the data available shows strong inflows into funds,tempered by less overseas demandThe final mutual fund/ETF flow data for Feb
35、ruary were released earlier this week.HG bond funds reported strong inflows of$17.7bn in February(excluding short-term funds).This was the strongest inflow month in over a year.January had inflows of$7.9bn.Inflows in Jan-Feb 2018 totaled$35.4bn,so above the$25.5bn over the same period this year,but
36、January last year alone was$31.1bn and was the largest month of inflows last year.In 4Q18 there were outflows of$22.0bn,and both 2Q18 and 3Q18 had very modest inflows of about$2.5bn,so the positive turn in these flows so far in 2019 is significant versus this history.Internationally domiciled HG bon
37、d funds reported inflows of$2.6bn in February,which is similar to the$2.9bn in this category in January.These positive figures come after 11 consecutive months of outflows from these funds in 2018.While the return to an inflow trend this year is positive,it is at about half the monthly average in 20
38、17 of$4.5bn.It is interesting to note that actively managed bond funds reported inflows in February for the first time since April 2018.Of the$17.7bn inflows that came in February,active bond funds saw$6.0bn(+0.4%of their AUM)and passive funds were responsible for the remaining$11.7bn(1.8%of AUM).YT
39、D inflows for active funds are$709mn(+0.1%of AUM)and$24.8bn for passive(+3.9%of AUM).Short-term bond funds also saw a pickup in flows,with inflows of$7.6bn in February.This is up from$5.8bn in January and$1.0bn in December but below the record high of$11.4bn in November.YTD inflows into short-term b
40、ond funds are$13.4bn(+2.1%of AUM of$648bn).For all of last year they were$58.7bn(+10.6%of AUM of$556bn).Note that all the data above includes all HG bond funds and ETFs,not just corporate-only funds.123951208914790958411898943010610081020406080100120140JanFebMarAprMayJunJulAugSepOctNovDec4yr Avg Gro
41、ss Issuance(2015-2018)2019 Gross Issuance$bn3383262972222860501001502002503003504001Q2Q3Q4Q4yr Avg Gross Issuance(2015-2018)2019 Gross Issuance$bn7North America Credit Research21 March 2019Eric Beinstein(1-212)834- Exhibit 9:The HG ex short term bond funds reported inflows of$17.7bn through the Febr
42、uary,a positive development from 4Q18Exhibit 10:The internationally domiciled HG bond funds rebounded with modest inflows in January and FebruarySource:J.P.Morgan,EPFR GlobalOverseas demand for US HG Credit has slowedAfter a strong start of the year,demand from overseas investors appears to haveslow
43、ed recently.We measure this through net dealer selling in overnight hours as per TRACE.Decreased realized yields for overseas investors buying US HG after the cost of hedging,regulatory changes abroad,and fiscal calendar related timing are all contributing factors.Dealers have been net buyers in ove
44、rnight hours during five of the last 10 overnight sessions.This is unusualdealers are generally net sellers.On average,dealers have net sold just$26mn/night over the past two weeks.This is significantly below the 2019 nightly average($153mn/night)and the 2018 nightly average($78mn/night).Exhibit 11:
45、Dealers have been net buyers of bonds in the NY overnight hours over the past two weeksSource:J.P.MorganThe yield that overseas investors earn on US HG credits after the cost of hedging has been coming down in recent weeks.FX hedging costs have decreased recently,but the yield of US HG corporates ha
46、s decreased at a faster pace.The result is a lower realized yield for overseas investors.Japanese investors can earn a realized yield of 105bp currently.This is down 34bp from 139bp in mid January.The annualized cost of a 3m FX hedge has decreased 8bp,and the yield on 7-10yr US HG bonds has decrease
47、d by 43bp.Similarly,the realized yield pickup for European investors has decreased by 42bp to 107bp since mid January.The USD/EUR 3m FX hedge cost has increased by 6bp,while the yield-50050100150200250300JanFebMarAprMayJunJulAug SepOctNovDec$bn2017201620192018-8-32712171Q163Q161Q173Q171Q183Q181Q19In
48、ternationally Domiciled USD HG BondFund Flows(incl short term)$bn-150-5050150250350450Jan-19Feb-19Mar-19Net Dealer Sells Volume/night,$mn2018 Average2019 Average8North America Credit Research21 March 2019Eric Beinstein(1-212)834- of US HG credit across the curve decreased 35bp since mid January.The
49、value proposition for Taiwanese investors has been relatively stable by comparison.The realized yield is now 205bp,10bp lower since mid January.Long-end US HG yields have decreased by 30bp,but a cheapening of FX hedges by 20bp partially offsets this.Exhibit 12:FX hedging costs have decreased slightl
50、y for JPY,TWD,and EUR based investors since mid JanuaryExhibit 13:Japanese investor realized yield has decreased 34bp since mid JanuarySource:J.P.MorganExhibit 14:Realized yield for EUR based investors is down 42bpExhibit 15:TWD based investor realized yield is little changed,-10bpSource:J.P.MorganA
