FW: Credit Market Strategist: Goodbye QE, hello QE - United States - 36pp

BofA Merrill Lynch Global Research

A Credit Strategy Report from Hans Mikkelsen

Friday, 31 October 2014

Credit Market Strategist

Goodbye QE, hello QE

·         With interest rate risk back following the FOMC statement, we have turned our tactical long into a tactical short. ·         The Energy sector has re-priced materially lower - but with further downside risk to oil we are cautious. ·         In 2015 we look for a 11% decline in high grade new issue supply to $950bn, led by industrials.

Goodbye QE, hello QE. As the Fed is ending QE, the Bank of Japan expanded its QE program to ¥80 trillion/year from ¥60-70 trillion (see: BoJ delivered unexpected easing). The biggest impact of these changes is a weaker yen relative to the dollar ‒ just as the dollar is strengthening against to the euro with the ECB likely embarking on QE next year. While weaker currencies have the potential to stimulate the global economy, with a relatively closed economy, the damage to the US growth story should be much more limited. However, as the US stock market is more global than the US economy, there are important impacts on the currency translation of foreign earnings. For credit, though, the larger companies that dominate the S&P 500 and have significant currency exposure tend to be highly rated and have little credit risk. Thus incremental earnings weakness hardly adds any credit risk. In contrast, companies with high credit risk and lower ratings tend to be smaller and have little foreign exposure. Hence there is little credit impact of currency risk. However, any QE-related downward pressure on JGB yields could further the reallocation of Japanese insurance assets into US IG corporate bonds.(Page 7) Goodbye QE, hello September. With the hawkish tilt to the FOMC statement the market is ‒ rightly so ‒ in the process of pulling forward the expected first Fed rate hike toward the middle of next year. That means the return of interest rate risk as a major concern for risk assets, as we saw in September. Hence we took off our tactical long position in IG held for the past roughly two weeks and replaced it with a tactical short. (Page 9) Low on oil. The surging US dollar since June has contributed to a sharp drop in oil prices. However, the net effect on the US economy is actually positive, as lower prices at the pump stimulate consumption, while most US shale oil production remains profitable at current price levels. Still profits in the Energy sector are at risk and credit and equity valuations have underperformed significantly. Despite this re-pricing, and resulting more attractive valuations, risks remain for the sector on further downside risks to oil prices, as our FX strategists expect the USD to strengthen further (see here).  (Page 11) 2015 high grade supply outlook. Lower interest rates and the resulting strong bond demand, as well as a rebound in financial issuance have allowed for record supply volumes this year ‒ which we estimate at $1.070tr. In 2015 we look for higher interest rates and deteriorating liquidity conditions to drive industrial issuance meaningfully lower, as the Fed's begins its rate hiking cycle. Additionally, EM issuance into our market faces significant headwinds in such environment. In contrast bank funding needs likely remain elevated in 2015 due to regulatory requirements, as well as more maturities. Hence we look for high grade new issuance volume to decline 11% to $950bn in 2015. (Page 20)