Managing Market Issues and Opportunities Amid Complex Pressures

Debt issuance has been modest, but there is significant building supply. The issuance context is continuing benchmark and credit spread disruption as markets react to competing pressures from the intersection of COVID, inflation, and a war in Europe. Issuers and investors share this complex moment, so the investor engagement and marketing process needs to be done very well.

SIFMA reset this week at 0.24% which is approximately 62% of 1-Month LIBOR and represents a 4 basis point adjustment versus the February 23 reset.

Managing Market Issues and Opportunities Amid Complex Pressures

I was 10 when the 1970s started and 20 when the decade ended—and I had a blast along the way. For my book, the 1970s were awesome. But while I was having fun, the adults of the day were confronting a new thing dubbed “stagflation,” which was the combination of inflation (mostly driven by price shocks from OPEC emerging as an oil market force) and low growth. For some market participants, the thesis today is that an array of factors, including shocks to the oil sub-economy due to the Russia-Ukraine conflict, will drive the same high inflation-slow growth dynamic as the 1970s. This would be an unfortunate retro trend.

Today is very different from the 1970s, but what we know is that the pressures of the moment are creating issues and opportunities across financial markets.

• Issue – Benchmark Rate Volatility: Since Russia initiated hostilities in Ukraine on February 24, Treasury rates have followed a somewhat unexpected path. As expected, in the days following the invasion Treasury rates moved lower following the typical flight to quality and de-risking move that accompanies major disruptions. But that initial downdraft didn’t hold, and as of last Thursday, March 10 the 30-year Treasury yield was up only 9 bps since the February 24 initiation of hostilities (but 26 bps from the flight to quality low). COVID is receding, inflation is the defining market issue, and the war is complicating everything.
• Issue – Credit Spreads: In the typical flight to quality scenario, benchmark rates decrease, and credit spreads widen–market participants sell risk assets and park the money in “risk free” Treasuries until the crisis passes and they feel confident enough to re-risk. Over the past several weeks, benchmark rates have edged higher and credit spreads have increased sharply, which places debt issuers in a difficult position. Given the amazingly accommodative markets of the last two years (and even pre-dating COVID), this is an important transition; hopefully, the jarring spread dislocations moderate, but the underlying factors driving it do not feel temporary.
• Opportunity – Low Rates: While benchmark interest rates are moving higher, they remain historically attractive. An important consideration will be whether the Fed acts as aggressively as expected to raise short-term interest rates or tempers their response to try to offset some of the growth dampening impact of higher oil prices (do they tolerate inflationary pressure points to try to defend growth). If the Fed adopts a less hawkish stance, then we might head toward a repeat of the 2009-2013 market which included a steep curve and a different fixed versus floating dynamic.
• Opportunity – Relative Value: While upward movements in Treasury rates have been unexpected, the other important trend has been tax-exempt rates moving higher faster. For most of COVID, tax-exempt ratios were low, but an abrupt shift in this dynamic has made it relatively more expensive to sell municipal bonds. This creates challenges in the cash market but opportunities in the basis swap market. Basis swaps allow organizations to trade relative value dislocations between the tax-exempt and taxable markets. When tax-exempt bonds trade at a high ratio to taxable bonds (which is happening now), basis swaps become a helpful tool for trying to offset the impact of the relatively higher cash market yields; when tax-exempt bonds trade at a low ratio (which was true for most of the COVID crisis era), new basis swaps are no longer needed because the cash market offers attractive yields.

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We entered 2022 with the looming pressures of inflation, a Fed poised to initiate a potentially abrupt shift in policy, and a host of post-COVID economic uncertainties. When Russia invaded Ukraine, we added the jarring dislocation of a war and as the conflict plays out, the growing realization that the critically important oil sub-economy may be dislocated for a while. Every turn offers only more uncertainty. This is the time to pay attention to market issues and opportunities. But even more important, it is the time to raise the financial planning bar and to fully commit to effective enterprise resource management. The headwinds aren’t transitory—the rate of inflation may moderate, but in its wake will be a structural reset in the expense base; any effective response needs to be holistic, integrated, and grounded in the dual resource management imperatives of resiliency and return.

Register for our upcoming webinar “Rating Agency Spring Update on the Pandemic, Labor and ESG” on April 6 at 10:00 am CDT. 

Trending in Healthcare Treasury and Capital Markets is a biweekly blog providing updates on changes in the capital markets and insights on the implications of industry trends for Treasury operations, authored by Kaufman Hall Managing Director Eric Jordahl.