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Welcome to the No More Risk Better, a Credit Sites Podcast. I'm Winnie Caesar, the Global Head of Strategy. And I'm Zach Rifis, the Credit Sites senior investment grade strategist. As strategists, we aim to make sense of the macro and the micro highlighting opportunities and the risks facing the fixed income markets.

As important as the macro call may be, we understand that credit investing at its core comes down to keen single name selection and we have credit sites benefit from the expertise of our team of over 100 analysts across the US, Europe, and Asia. This podcast offers a look at the conversations that we have with our analysts on a regular basis. If you are an investment professional focused on the wide universe of fixed income, you'll want to give this podcast a listen. Hello, everyone, and welcome back to the Credit Sites Podcast.

This is Winnie Caesar, Global Head of Strategy at Credit Sites. And after a little summer holiday, I am really excited to be back in the podcasting seats. Now this season is going to be a little bit different because my colleague Zach Rifis is out on paternity leave. So I'm having to step up a little bit more, but I also have some excellent colleagues to help me out.

And today we have Logan Miller, our head of European Strategy. He is going to do a handful of podcasts focused on the Euromarkets over the course of the season. And today we're just going to set the stage for what to expect this season. Some of the market happenings over the past couple of months and our expectations for the Burr month, September, October, November and December.

Logan, thank you so much for joining me today. Yeah, thanks for having me. I'm looking forward to a great podcast season coming forward. Me too.

I really enjoy the podcast. This is one of my favorite parts of the job for sure. So Logan, I wanted to start and just maybe you could highlight some of the things that you have been working on with the team in Europe, maybe some of the things that you're contemplating doing for the end of the year. Yeah, sure.

I think, you know, for once, you know, we've seen a rush of new issue deals in recent weeks. And I think we're things today, conditions seem quite ripe for borrowers to continue chipping away at near-term financing needs. So I think in the very near term, we're very much focused on primary market expectations after a very robust year to date for European IG issuance. We've also seen a nice rebound in high yield activity so far this year after a fairly quiet 2022 and 2023.

So that sort of is near and dear right now. You know, I think estimating obviously that the sheer volume of issuance need is important, which we expect to be quite sizable in the coming months. But I think another important element to your role strategy is diving really into the trends in primary market activity, which I think is what helps investors with positioning. So our team right now is working on a bottom up forecast for potential issuance across sectors of the Euro IG and high yield market.

Another key focus right now is understanding where the consumer is heading after proving to be quite resilient in recent years, you know, with uncertainty around the economic outlook, some softening of labor market data as well as, you know, some declining inflation pressures. We're putting a lot of effort into understanding how consumer behaviors are changing across what I would call the discretionary spending categories, particularly in high ticket items, such as auto, as luxury retail, as well as travel. So I think this is going to be a key driver of relative performance over the next six to 12 months. And then the last thing I would mention is, you know, we're very much focused on how to be positioned for lower rates.

I think investors have been fighting an uphill battle against central banks over the last two years. And I think now that central banks are no longer off sides on inflation and now are looking to ease policy rates from super restrictive territory. I think that's going to be a key driver of markets going forward. You know, this should be an argue, a good thing for credit quality, particularly in some of the rates of sectors of the economy and also, you know, a positive catalyst for some of the higher-level companies that are now, you know, now that refinancing concerns are starting to ease back a bit.

So those are some of the key things we're focused on. I think taking more of a kind of nuanced and focused approach to trade ideas, you know, identifying parts of the markets, parts of the opportunities in the crossover space that's looking for, you know, opportunities within kind of low-triple Bs to high-single Bs. I think that's going to be a key area of relative performance this year. But thankfully, we have a great team of analysts here in Europe who can help us identify some of the many credits in space.

That sounds like a great lineup for the rest of the year. For certain, and I know that in the US, we're also very focused on the primary market. US investment grade is on track to meet our forecast expectation of 1.5 trillion of issuance, which when you consider where all in borrowing costs are right now, you know, they're still pretty high compared to the prior high-water mark issuance years of 2020 and 2021. It's a big year, definitely, that a lot of people were not anticipating and whether we continue to see such a robust pace of issuance in 2025 is definitely something that we are contemplating right now.

And similarly, that state of the consumer, which really drove a lot of volatility in late July and early August, is something that I think everyone is trying to assess and reassess. I think that the expectation that good spending is still going to be a little bit tougher for the foreseeable future, but service to spending has been all over the place as have labor markets. And in the US, we had that July payrolls print that came in much lower than people anticipated unemployment coming in higher than people anticipated, potentially triggering that some rule depending on how you round, how many digits you round out to. And with that, credit spreads really reacted very quickly, gapping significantly wider in the US.

We had a recent wide of 112 basis points in USIG, 393 in US high yield. And what's interesting to me is how quickly people really reprised Fed cutting expectations. Before that, not very many cuts priced into the markets. And then after that payrolls report, we had pretty jumbo cuts with 50 plus basis points of cuts priced in to every meeting from September, November, and December.

And even contemplation of a potential emergency or inter-meeting Fed rate cut. We thought that the reaction was really overdone. We have been a little bit more cautious on spreads being on the trajectory to move wider over the next call it nine to 12 months or so, rather than continuing to grind tighter. But we don't think that the Fed is going to be cutting by 50 basis points, at least not in any of the near term meetings.

And with that, we did say, you know, continue to be a little bit more defensive in portfolio strategy. We think that single A relative value looks a little bit better than triple B. We still like that barbell strategy, depending on if you are excess or total return benchmark in the investment grade market. And within a high yield, we just don't see that massive upside potential from triple C's to outweigh, you know, what we have for double B's.

Now, Logan, I do agree with you that some of the funding considerations are probably easing up a bit for some of the lower rated issuers. But this year has just been so spectacular from a market receptivity standpoint, that I'm a little skeptical that it's going to, you know, last in perpetuity. So Logan, how did European spreads react to that volatility that was really driven by the US jobs report and then also that unwind of the yen carry trade? Yeah, it was certainly some pretty big moves across credit.

I think, you know, if you look at some of the derivatives, CDS land, I think that certainly reacted the most and definitely more than cash spreads. But certainly it was pretty meaningful, you know, bounce of volatility. But I would say all things considered, European markets actually held up quite well, especially in the early part of August. And we definitely saw some spread winding as we saw a meaningful rally and kind of global sovereign bond yields.

But, you know, I think the technicals that have supported credit for most of this year, certainly ended up prevailing. And one of the key drivers here was that we saw very light issuance across European credit in the first part of August. Basically had no new deals up until, you know, the second to last week of the month. So I think that certainly helped alleviate at least some of the selling pressure.

It did feel to me like it was a bit of a thin liquidity market. So that certainly helped, you know, cause things to kind of gap out more than we would have thought on sort of a weaker jobs print. But, you know, at the same time, you know, if you look at some of the flows data, you know, demand for European fixed income continued to be positive kind of throughout, you know, the last month or so, you know, we had kind of a week of sort of slight outflow, but it seemed to be more directed toward, you know, one single fund rather than, you know, widespread outflows from some of the volatility. So yeah, I think these factors, you know, kind of helped spread quickly rebound after the knee jerk move wider.

In fact, excess returns for EuroIG are nearly back to the year to date high watermark while total returns were also given a extra boost from declining benchmark yield. So things certainly kind of came back to normal pretty quickly. Then you also saw the new issue market ramp up in sort of the third week of August. We actually ended up getting about 42 and a half billion euros of a VIG issue once for the month, which all came in the last two weeks of August as sort of the primary market reopened after closing the first half of the month.

So I think that's a testament to really the fact that demand is still strong for corporate credit. Investors are still looking to kind of lock in these higher yields before the ECB and other central banks start to cut rates. So I think that's kind of the prevailing factor that's been driving markets in the last few weeks. So I guess this narrative that we have in the states around people not working at all in August in the UK and Europe is not accurate if you were able to price that much within the new issue market in the last two weeks of August alone.

Now, Logan, one thing that I think is interesting is there have been some recent inflation data prints in the Eurozone that have actually been really encouraging. I am shocked to have seen Euro inflation moving closer to that 2% target at a pretty rapid clip. I would have expected Euro inflation to get a little bit stuck at elevated levels, giving some of the structural underpinnings of the Eurozone economy. And at the same time, growth forecasts are pretty positive.

This seems like a very goldy locks outcome for the European Union macro economy. Is the ECB declaring victory? Are there any risks to this kind of positive outcome? Yeah, I think in terms of the macro, I'm actually quite constructive on the outlook.

At least through your end, while we have obviously seen a few pockets of weakness in some of the earnings results released for the second quarter, I think credit fundamentals generally are still holding up quite well. Companies still have pretty elevated cash balances. And so I think that's providing a nice buffer in the wake of sort of still high borrowing costs. But I think the prospect of lower interest rates going forward is going to be a nice tailwind for companies to really shore up near-termaturities and start shipping away at some of the higher interest costs that were locked in over the past few years.

So yeah, I think in terms of economic growth, it seems like the probability of recession still remains quite low broadly. I think there's been a bit more of a benign political environment in the UK. So that's probably shifted the balance of risk to the upside, at least on the UK side, with potential for tweaks to the tax code really offset by improving wages. And at the same time, lower interest rates should provide some early to the consumer and also support business investment.

In Europe, the broader economy is still benefiting from a resilient consumer and still strong levels of government spending. That being said, I think there are some risks here, especially if you look at some of the manufacturing heavy countries like Germany, even yesterday, we saw also Agnes proposed to close or at least slow production in Germany for the first time really since going all the way back to the 40s. So I think that's certainly a bit concerning in terms of the growth here. At the same time, you have some negative political risks that could come back to the forefront.

France has to decide on its next prime minister after the snap elections in late June, early July. And then also, France will need to delude on its budget framework in the coming weeks. So I think there is some risk that political volatility comes back to the surface. You mentioned inflation.

I think, in my view, it's still too early to call the signal really all clear in terms of core prices heading back to that 2% target in the very near term, particularly as wage growth is keeping services and inflation relatively sticky. And that goes for both the Eurozone and the UK. But I think really the medium term inflation outlook is becoming much more balanced compared to this time last year. Labor markets have become less under supplied.

And so we expect this to continue even as central banks start to ease off the break. So economic terms, I think this should lower the pressure on companies to push through high prices to consumers. So certainly helps from that standpoint. And then from a fundamental standpoint, lower interest rates and you couple that with kind of disinflation of the cost of doing business, I think that should be supportive of margins and obviously lead to some positive bottom line growth figures as well.

So I think the short message is that we expect spreads in EuroIG and Hyel to stay relatively tight range. But but finished the year, modestly wider from current levels with perhaps some indigestion coming from heavy supply and then a degree of kind of profit taking after a really healthy year to date for both excess and total returns. Meanwhile, we think Sterling IG is still relatively attractive and we think spreads can grind modestly tighter from here really due to limited new issue supply and and still still strong demand for high all in corporate bond yields. Well, Logan, I don't know that I'm used to be to you being so bullish.

You are not one of the Uber bulls and you had some great calls last year when we were discussing sovereign yields, you know, potentially moving higher and you had a pretty high conviction view there. On the central bank side of things, you know, we do have a pretty action packed lineup in September. And then again, in November of December, I feel like we have a lot on the economic and geopolitical calendar and our expectations are that the Fed begins. It's much awaited cutting cycle with its September 18 meeting with a 25 basis point rate cut.

We have not ascribed to the 50 point cuts that the market was previously bracing in or any of those intra meeting kind of emergency cuts that the market was discussing around that July payrolls print. But we do think that 75 basis points of accommodation over the next three meetings probably makes some reasonable sense, especially after Powell's comments at Jackson Hole, where it is clear that the Fed has shifted away from its laser focus on inflation and toward ensuring that the labor market remains fairly balanced. And we've definitely seen some signs of erosion in the labor market and some signs of kind of continued deceleration, especially on that industrial side of the economy. It is kind of amazing how globally the industrial side of the economy has really been lagging even with a lot of spending, especially from the US federal government under the inflation reduction act to try to continue to drive thing.

Logan, what is your expectation for central bank policy over the next few months, both the ECB and the BOE? Yeah, I think I'm still comfortable with our call for the ECB to cut rates by 25 basis points two more times this year. So that would bring the total cuts for the year to 75 basis points, which is a bit less than what the market is currently anticipating. I do think the ECB is going to go again in September at the upcoming meeting.

And then our view on the Bank of England has been a bit less delvis than the market, but we actually did see a first rate cut coming in September, but instead the central bank decided to go on the first of August when I was actually on holiday. So that was a lot of fun. But my base case now is that the Bank of England basically stays on hold at the next meeting and then goes again in the second to last meeting of the year. But I think really for both central banks, data dependency is going to be key.

Like you mentioned, your zone inflation has been coming down nicely, same thing with the UK. I do think there's some degree of base effect in there from high inflation at this time last year. So perhaps we kind of get a little bit less progress on headline numbers going forward. But I think if you listen to what central bankers are saying, they seem to be quite comfortable with the risks to inflation.

They continue to point to the upside surprises going forward. So I think that's going to be quite constructive for the central banks to start to cut rates in the last few months of this year. But I think the bigger question really is, and I think what is going to be more impactful to markets is around how much central banks can cut over the next 12 months, 12, 18 months. What are the long term or neutral rates going to be going forward?

And then also where we could see some divergences between monetary policy decisions as I think this ultimately will impact cross-border flows, effects hedging costs, and then ultimately the economic growth outlook. So I think those are the big question marks going forward. We're still doing our analysis on where we think rates will be this time next year. But I think the very near term, our view is basically that we expect central bank policy to be kind of in sync globally.

And so we don't see any major reason for either the kind of main central banks in Europe or the UK to really diverge meaningfully from each other. So I think that's kind of the near term view. That seems to be also what the market is sort of pricing at this point. So kind of a modest reduction, but no sort of major, major rate cuts, at least overnight.

All right. So moving toward a globally coordinated kind of slow easing cycle across at least the ECB, the Fed, and the BOE. I would enjoy that. I think that I am ready for that.

Something different to talk about than inflation, inflation, and rate hikes and type policy. Now, one thing that I'm already sick of talking about, but I think we'll probably come up a good bit over the next couple of months and maybe even further is the US presidential and congressional election, which we are now almost exactly two months away from on November 5th. And one thing that I'm really focused on is the revival of the debt ceiling debate as the debt ceiling suspension actually ends on January 2nd, 2025, which is really strange timing because we have the presidential and congressional election on November 5th. But we don't have the actual commencement of the next congressional term with the newly elected senators and representatives until January 3rd and then January 20th is our presidential inauguration day.

So you might end up with a December gridlock on this debt ceiling suspension because none of the new members of Congress and whomever is going to win the presidential election are not going to be in their seat until January. And so you have this kind of lame duck outcome. And usually we say that gridlock is okay for markets in that you probably are not going to be seeing massive sweeping policy change. But if you have gridlock ahead of that suspension of the debt ceiling ending, that doesn't seem like a great outcome to me.

And so when we're thinking out kind of the game theory of, all right, if we have a Republican sweep versus a Democratic sweep versus gridlock, all three of those things seem to have some not so great market implications, especially because fiscal deficits and spending have become a much bigger point of focus for a lot of the investors that I talk to and the market as a whole. Now, the good news is we have seen Treasury supply digested pretty nicely over the course of the year, even as yields have fallen, even as we've seen some musical chairs on the presidential election side of things. So we can't say that these fiscal deficits are just cutting off demand for US treasuries. And that includes from foreign investors, non-US investors are continuing to add treasuries at a pretty healthy pace over the course of the year.

But it is absolutely something that we are keeping an eye on. And we will be talking more about the revival of the debt ceiling debate later on in the podcast. We'll have Mark Leitner, who is our head of US legal special situations research to talk about some of the interesting moving pieces related to the election and the debt ceiling. Now, Logan, you talked about this a little bit, but I wanted to revisit the fundamentals versus technicals.

I think that in the US, technicals have absolutely been driving performance for the bulk of this year. We maybe had a brief blip of fundamentals, at least fundamental concern taking over in that last week of July, first week of August, as expectations around the labor market and Fed rate cuts shifted a little bit. People started worry about the potential for a consumer's let's slow down and potential recession. But for the vast majority of the year, it has all been about flows into fixed income, demand for fixed income, very strong primary markets, and seeing that the strong technicals there actually improve fundamentals across investment grade, high yield and leverage loans.

What do you think has been really driving the bulk of performance in the Euro market? And what would it take for fundamentals to take over? How bad does it need to appear for investors to get concerned again about recession risk and fundamentals? Yeah, it's a really question.

I mean, I certainly think technicals have overwhelmed fundamentals so far this year. Not the fundamentals have been bad by any means. But you have had a few major situations emerge, especially down the rating spectrum and high yield, a handful of larger defaults. But I think the technicals have been so strong that any time we get a negative headline event for an individual issue or whatever it might be, it tends to get bought pretty quickly.

And I think the volatility that we got early August was certainly telling of just how strong demand continues to be for fixed income really globally. To be honest, I think that's been really helping some of the big beta compression trades work in favor of investors this year. If you look at performance across the European markets, it's really been anything with outside spread or anything that kind of lag over the course of 2022 through sort of mid-2023. That stuff's really been outperforming quite nicely.

So certainly it's been beta compression coupled with carry in sectors that are trading at wider spread levels. But in IG, in particular, I think credit risk has worked over duration risk. Again, some of the widest trading sectors of IG have certainly outperformed. But if you look at performance across the curve, the long end is actually underperformed quite meaningfully on both an excess return and a till return basis.

So typically, when you have beta compression, you have investors moving down the rating spectrum and also going out in duration. But that actually has been more about buying, moving down credit quality rather than moving out in spread duration. So I think that's been sort of an interesting dynamic that's played out so far this year. We've also seen kind of a normalization of the spread curve.

So it's really benefited to be sort of in that belly that that three to seven year bucket of the year IG market that we've been recommending so far this year. That's that trade has worked out quite nicely, both from an excess return and total return standpoint. I think more recently, the front end is getting a nice boost from expectations for lower front and yields, lower ECB rates. That's helping the very front of the market.

And then in high yield, this year has been about avoiding event risk. Like I mentioned, we've had a handful of sort of large stress situations emerge, which have certainly been quite painful for people who own some of those credits. But but triple C's have really been the most volatile segment of the year market so far this year. Triple C's an aggregate have really swung from massive underperformance to now outperforming on a total return basis so far this year.

I think the handful defaults that we've got in this year has made the European high market a bit more higher quality. So probably less concern about new situations emerging, but nonetheless, I think it's really been kind of a choppy year for performance in high yield, despite absolute returns being kind of positive across the board. It really depends on sort of the timing and also credit selection within high yield. So I think just to your last question, what would it take for fundamentals to take over?

I think you have to see really the outlook for growth change materially. Right now, it seems rather segue if you look at just sort of economic forecast for GDP growth across the Eurozone, across the UK, seems modestly positive for the next 12 to 18 months. I think if there is kind of renewed fears around hard landing, that would certainly lead fundamentals to take over. And if you see long end bond yields drop significantly on that recession risk, I think that would certainly weigh on on technicals and then you start to have more concerns about fundamentals as well.

So these dynamics are all sort of intertwined. They all have some sort of interplay, but right now it seems like we're lacking sort of major catalyst for fundamentals to really take hold. Yeah, I would agree with that. It's really tricky to articulate what that catalyst is going to be because we do not have a recession in our base case.

We do think that the consumer is going to slow down. I do still kind of have some fears or concerns around any consumer slowing is going to be met with, I think, fear by the market. We saw that absolutely in July around the payrolls data and the rest of the consumer data over the course of August was relatively strong and really soothed some of those fears. It's interesting to see how the long end in investment grade and then high yield triple C's in the US markets have been kind of laggards and underperforming a little bit just as we've seen some shifting expectations around liability management transactions and what that means for the broader triple C cohort, some fear around physicians in telco and media still.

And so I do think that kind of staying a little bit risk off a little bit up in quality within the market does make some sense as that potential for a shifting fundamental landscape and perhaps technicals not being quite as strong as they have been, something that gives me a little bit of pause, especially heading into the political season, the debt ceiling debates and just at the end of the year as a whole. Well, Logan, we can wrap this up here. Thank you so much for joining. We do have a great podcast lineup for the remainder of season seven, which will run from early September to mid-November.

We're going to be getting some updates on the new issue outlook with our colleagues in LFI. We're going to take a look at what's going on in private credit, get an update there, talk to our consumer team, both in the US and Europe, what has transpired in the consumer complex. Also think a little bit about real estate and the housing market as there's been a lot of headlines around those two sectors in the US and Europe. And of course, we're going to do a lot of election focused podcasts, setting the stage with an election countdown, a legal election focus, what's going on with US health insurance in the context of the election.

Now, as always, if anyone has questions from your Logan, you can reach out to us on thecreditsites.com website by using that Ask an Analyst function. And if you have suggestions for podcasts, if you have topics that you want us to discuss, feel free to send those in as well. We love getting reverse inquiry. It is really helpful for us to know what everyone else is thinking about, wondering about, or just discussing.

Logan, thank you so much for joining me. Thank you so much for helping me with the podcast this season. I think it is going to be a great one. Absolutely.

All right. Thank you, everyone, for listening. And we will be back in a couple of days. Credit sites to SLEMR.

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