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June 2021 | Issue 235
Credit markets heed early indicators of inflation pressure
Hugh Minch
Inflation became the topic du jour after the consumer price index (CPI) grew 4.2% in April, its highest rate since September 2008 and much higher than the 3.6% many analysts predicted. But debate rages over whether the data represents an urgent concern or whether the numbers are a natural effect of the economy reopening following the easing of the coronavirus pandemic in the US.
Scott Snell, portfolio manager at Tetragon Credit Partners, says the major indicators of inflation all appear to be rising, including the CPI and producer price index, home prices, material costs and labour costs.
“There is a debate on whether it’s temporary or whether it will be more sustained,” Snell says. “Because of the pandemic, supply chains have been interrupted across a number of industries, which means companies are not able to produce as many goods as people want, while demand is gaining strength. My view is that this will persist for an extended period of time, and it might not be as temporary as the Federal Reserve is forecasting.”
Federal Reserve vice chair Richard Clarida described the latest CPI numbers as an “unpleasant surprise” in late May, but added that he continued to believe current inflation will prove to be “largely transitory”.
“My view is that this will persist for an extended period”
Scott Snell, Portfolio manager | Tetragon Credit Partners
He also raised the possibility of the Fed raising rates in the near term.
As floating-rate products, CLOs look well placed to benefit from inflation, and are arguably already benefiting from predictions of inflation given investor demand for CLO tranches.
“You’re seeing quite a bit of demand for CLO debt up and down the capital structure, resulting in tighter spreads,” says Snell. “Currently, the cost of capital for new issue CLOs is 10 to 15 basis points off the recent tights in 2018, despite close to $160 billion of issuance this year.”
The sentiment that inflationary trends are more than an effect of the economy reopening is more broadly shared.
Writing in late May, TwentyFour Asset Management partner and portfolio manager Felipe Villarroel extrapolated from average hourly earnings data that wages could hit more than 4% year-on-year growth by July.
“If the market begins to take this wage data as a serious indicator of more persistent inflation then, along with the prospect of the inevitable taper we expect to come from the Fed, this may be enough to produce a period of profit-taking in risk assets,” wrote Villarroel.
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Global credit funds & CLO's
June 2021 | Issue 235
Published in London & New York.
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