Asset Backed Securities

Given the material positive performance seen in other parts of the fixed income markets in 2019, the CLO relative value proposition now looks even more attractive.

We have already highlighted the blistering pace of bond sales in both Europe and the US, and this being met with apparently insatiable demand from fixed income investors. Since European ABS markets tend to lag broader fixed income, it seems fitting that we have had to wait another week before seeing that primary machine start to accelerate.

It is not clear to us just how much more monetary easing will placate equity investors, and we see a real risk that when we enter the third quarter earnings season next week, company specific data from the bottom up will be more of a shock than the macro picture has been.

Rates risk is not something we concern ourselves with too much in the European ABS market, so normally news of inverted yield curves and 30-year US Treasury yields dropping below 2% would largely wash over us. This is because pretty much all ABS bonds are floating rate, so there is no duration. Or is there?

One of the market’s chief obsessions in 2019 has understandably been the shifting stance of the US Federal Reserve in relation to the path for interest rates, with investors now pricing in a 100% chance of a rate cut at the end of this month. Now that the June FOMC minutes, Nonfarm payrolls, Jerome Powell’s testimony to Congress, the June CPI and PPI numbers and the Trump-Xi meeting at the G20 in Osaka are behind us, what is the next set of data that may shed some light on the Fed’s next policy move?

Yesterday we heard from US Federal Reserve Chairman, Jerome Powell, as he testified at the House Committee on Financial Services. Obviously the main focus for markets was to glean any additional information regarding the future timing and path of the Fed Funds rate. However, as important for fixed income investors as the future path for rates is, listening carefully to central bankers can also provide insight into the bigger picture economic environment. My ears pricked up in particular at two important and related topics Mr Powell discussed.

While many credit markets have experienced a significant rebound from the broad spread widening of late 2018, muted primary market activity has meant European ABS spreads have lagged the trend. TwentyFour Asset Management’s Ben Hayward explains why he believes this has created a potentially short-lived relative value opportunity for investors.

“…everybody’s having fun. Look to the future now, it’s only just begun.”

Bloomberg reported on Monday that since the European Central Bank started its Corporate Sector Purchase Program (CSPP) in June 2016, it has purchased €177bn of investment grade rated corporate bonds. Initially, as expected, spreads tightened rapidly, but since the first quarter of 2018, they have been gradually widening back out to pre-CSPP levels.

On Monday my colleagues on TwentyFour’s Multi-Sector Bond desk published a blog on rising default risks in high yield credit. Dummen Orange, Douglas, Boparan, Moby, Galapagos and CMC Ravenna are some of the obvious under-pressure names held in loan funds and CLO portfolios that are trading at a significant discount in the market.

Changes in regulations are typically long and drawn out, but their impact can often be felt quite quickly. There is every chance that this could soon be the case in ABS markets.

At TwentyFour our Italian ABS holdings are fairly moderate, and in general our peripheral ABS exposure has been steadily decreasing for some time. This has nothing to do with credit quality, but everything to do with relative value.