Central Bank policy still tightening
Another week, another round of interest rate increases. With the Federal Reserve having led the inflation fighting charge on the part of Western Central Banks, its 25bp increase to a 4.5-4.75% target range represents an easing off of the rate of increases. With the Bank of England following on with a 50bps increase, taking its policy rate to 4% – a 14 year high – and the ECB also hiking by 50bps to 2.5%, the squeeze on indebted households and borrowers (including governments) continues.
In the UK and the US, the housing market is already showing signs of stress, unsurprisingly in the US, where the benchmark 30-year mortgage rate has gone from sub 3% to as high as 7% before falling back to north of 6% this is having a negative impact on both new housing orders and house prices, although, the effects seem to vary regionally. In the UK, December house prices fell for the fifth month in a row, the longest decline since the market correction in 2008-09, with mortgage rates in December averaging 3.67%, the highest in a decade. Savills’ latest forecast shows UK house prices falling by an average of 10% during 2023 – when even the estate agents are this bearish, you know the housing market outlook is gloomy.
For the UK, the dark economic outlook continued with the IMF forecasting that the UK would be the only G7 economy to contract in 2023, citing high taxes, increased interest rates, high energy prices and a squeeze on government spending. The IMF forecasts will place further pressure on Jeremy Hunt from his own backbenches to shift back to a more growth-oriented strategy in the forthcoming budget.
Improved sentiment in public & private debt markets in early 2023
Despite the various storm clouds, there were some reasons to be cheerful as the new year commenced. As we know, 2022 was a pretty ferocious year regarding funding markets and volatility across inflation, rates and energy costs. The resulting melee caught many off-guard with the result that public debt and equity markets ground to a virtual standstill at times with volumes massively down on previous years. Although private markets picked up a certain amount of the slack, price discovery becomes increasingly challenging without visibility of reliable public market benchmarks. Being a fickle bunch, investors appear to have rediscovered their nerve over the Christmas break and January saw record levels of issuance in the Euro fixed income market. Although Sterling was less active, there is a clear return of appetite and liquidity as reflected in new issue premia for primary bond issues which are tight to negative, underlining a major shift in investor sentiment.
This is also reflected in buoyant private credit and banking markets at the current time as evidenced by deals that we have in the market for housing, infrastructure, energy and real estate clients. As a result, borrowers are dusting off investment and capex plans which were quietly deferred last year and showing a greater willingness to re-enter funding markets, particularly with all-in rates significantly lower than the levels reached during the UK market spasms of last September. To put this in context, the underlying 5, 10 and 30-year gilt/swap rates are circa 1.5-1.75% down from the highs of last year and credit spreads are 50-100bps lower depending upon the credit rating and sector in question.
Although I appear to have missed my invitation, colleagues from our Investor Coverage team had the tough task of departing the UK winter and heading to the US Private Placement Industry Forum in Miami. The positive early 2023 tone was also very much in evidence from the many US institutional investors they met over there with a strong appetite confirmed for strong credits across affordable housing, real estate (secured and unsecured in both cases) and infrastructure. 2022 underlined the need for borrowers to maintain flexibility and access to different sources of capital and given the depth of the US market, this remains an important option for many debt issuers.
Given the gyrations of 2022, we are seeing a renewed focus on risk management across our client base across rates, inflation and power/energy costs. Even though borrowing costs have fallen materially, along with wholesale gas and electricity prices, clients are keen to take risk off the table and to lock down certainty in their business plans wherever possible, even if on balance they expect markets to move further in their favour.
So, in spite of the challenging backdrop, debt markets have very positive sentiment and strong momentum into February, which we hope will set the tone for the rest of 2023.
For more information on any of the topics mentioned, please contact a member of our team or email london@centrusadvisors.com
