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Cross Asset Desk Strategy | November 18, 2021


Citi Global Markets | Cross Asset Desk Strategy

November 18, 2021

Looking Ahead 2022



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OverviewAs expressed recently by Citi Research, inflation trends globally present a real (rate) conundrum.

Looking into 2022, Citi Markets’ cross asset desk strategists zone in on that very issue, anticipating that persistent inflation and a tightening of financial conditions will translate into select macro opportunities near term:

• Rates: UST Belly at Risk

• Equities: Tightening Rotation

• FX: Divergences Drive Dollar Higher

• Credit: European IG – Not So Tough

• EM: Credit Spotlight – Alpha in China, CEEMEA and LatAm Contingent

We invite you to engage more on Citi Velocity via our Outlook Page, showcasing additional Market Commentary from our desk strategists, traders and salespeople globally, as well as our official house forecasts from Citi Research. We appreciate the opportunity to serve our clients and look forward to our journey ahead.

Sincerely,

Aerin Smith Global Head of Market Commentary, Citi [email protected]

https://www.citivelocity.com/cv2/go/Outlooks



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Table of ContentsContacts ..................................................................................................................................................................................................... 03

Looking Ahead Events ...................................................................................................................................................................... 04

Rates: UST Belly at Risk by William O’Donnell, Tom Fitzpatrick ........................................................................................... 05

As the Fed moves further down the road toward policy tightening and inflation remains sticky, particularly for shelter prices, the 5y point on the curve will move into the firing line. On a technical basis, our interest rate bible, the 2s5s spread, appears set-up for more steepening.

Equities: Tightening Rotation by Alex Altmann, Mohammed Apabhai, Jimmy Conway ................................................ 07

The key question for equities is how well the multiple can absorb a higher CPI regime. The Growth multiple appears most at risk and we therefore expect the rotation trade to find even firmer footing.

FX: Divergences Drive Dollar Higher by Ebrahim Rahbari, Calvin Tse, Stephen Leach, Lenny Jin........................... 09

We expect growth divergence and policy divergence between the US and the Eurozone to push EURUSD lower and DXY higher into 2022, supported by French election risks. For EM FX specifically, it remains unlikely to see (even accelerated) hikes from emerging market central banks translate into FX strength. CZK may remain an exception.

Credit: European IG – Not So Tough by Lee Street, Joe Faith ............................................................................................ 12

Conditions for IG spreads into 2022 appear tough on the face of it, given declining central bank support, credit yields at close to historic lows and M&A and capex funding liable to drive up supply. Yet the technical factors supporting credit – i.e. asset purchases from the ECB – could be more resilient than some expect.

EM: Alpha in China, CEEMEA and LatAm Contingent by Asia – Manjesh Verma, Stella Li, Jiren Zhang;CEEMEA – Ayso Van Eysinga, Milena Ianeva; LatAm – Miguel Garcia de Onrubia, Ayoti Mittra, Albert Chang ...................... 14

EM credit has had a sobering year with Asia returns sharply negative due to Asia HY selloff, LatAm credit experiencing a rough ride and CEEMEA credit returns barely positive. Looking ahead to 2022, we think the key alpha is in China HY, and with a pivotal few weeks ahead will be looking to add risk. We take note of some selected HY sovereigns in LatAm and CEEMEA and highlight a few themes we expect across the regions as well.

Disclaimer .................................................................................................................................................................................................. 18



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Events

Asia/London CallThursday, November 18thHong Kong: 4:00 pmLondon: 8:00 am

View live and replay

FedLive: Citi Reacts to the Latest FOMC Decision Wednesday, December 15th New York: 3:30 pm


London/New York CallThursday, November 18thLondon: 1:30 pmNew York: 8:30 am


BoE/ECBLive: Citi Reacts to the Latest ECB & BoE DecisionsThursday, December 16th New York: 9:30 am


Looking Ahead with our Cross Asset Desk Strategists

Live Coverage for December Central Bank Meetings

Visit Outlook Page on Citi Velocity for More

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https://www.citivelocity.com/t/eppublic/2EwnP

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Rates: UST Belly at Risk by William O’Donnell

Front-end bonds have the ‘most to lose’ as we head into and through 2022. That’s not a controversial view, but 7y and 30y yields have already recaptured levels seen in the months before the pandemic, and 5y has yet to do so.

The 1.31% level marks the bottom of pre-pandemic rate range for 5y and yields are closing in on that quickly (Figure 1). A core fundamental worry of ours is that Shelter prices remain firm/higher through next year given the ~18-month lag between PCE Shelter and home price appreciation (YoY%). If the correlation holds up then we would imagine that inflation can stay elevated even if some goods prices normalize along with supply chains, etc. next year. Remind that Citi Research US Economics sees potential for accelerated Fed tapering and three hikes in 2022.

If inflation persists next year (and beyond), where could Treasury 5y yields get to? Back in the 2018 tightening cycle 5y yields got as high as 3.1% in December 2018, which matched up perfectly with a secular bull trend in 5y yields in place since January 1995’s high yield print. This multi-decade trendline would come in at 2.25% in December of next year. In my view, that’s as good a year-end upside target as any. Looking to the short-end, if 2y yields rise above 0.56%, there is little support until 1.31%, a consequence of the straight-shot plunge in rates during late February and early March of 2020.

In the long-end of the curve, 30y Treasury yields are currently in no man’s land. Not far from the middle of their bull channel in place since the GFC, 1.80% remains a local resistance area while range support remains near 2.44%. We don’t have any strong views on 30y, though we do note that medium and long-term momentum studies aim bullishly at the moment- a hint that ~1.80% resistance may be challenged again soon and that 30y should go into 2022 on a solid or on-balance bullish footing. As for yield curves, the 5s30s curve remains in a sustainable-looking flattening trend- one that began in May of this year.

During a recent client dinner, a number of CIO’s I sat with complained about potential or probable bubble-like valuations in their markets. There was wide agreement that real rates were too low (pacing the risk valuations) and that the Fed’s balance sheet may be the most effective tool to elevate real rates and cool risk markets. Still, no one really thought a 2% Fed funds rate would do much to take valuations off a potentially dangerous boil. Real rates can stay depressed so long as the Fed does not rattle that sabre.

Figure 1. US 5y – Still a Bear

Source: Citi, Bloomberg

https://www.citivelocity.com/t/r/eppublic/2Eyg8



by Tom Fitzpatrick

For more than a quarter of a century the spread between 2y and 5y yields has been our interest rate bible in terms of what we are looking at in yield direction, curve direction and ultimately Fed policy. Today, the set-up argues for further bear steepening.

Long-term picture. Over the long-term the 2s5s curve has been our favorite interest rate chart for two reasons. Its amazing symmetry and its consistent signalling power. If we take the long-term chart going back over 30 years (Figure 2), one can see: three structural highs within a 10bp range (+160 to +170 basis points); and, four structural lows also contained within a 10 basis point range. All four lows have been posted as the curve inverted after a Fed tightening cycle (could be a small cause/part of their new more moderate tightening policy).

All four lows preceded a “crisis.” In 1989, the housing and savings and loan crisis and at the time the second deepest recession period (behind the 1970s). Within weeks of the -22bp low being posted, the Fed began cutting rates creating a bull steepening. In 2000, the Dot-com bubble and crash saw the biggest major Equity market fall since the crash of 1929-1932, against within weeks of -25bp low, the Fed started cutting rates creating a bull steepening. Then in 2006, The great financial crisis where then the Fed waited 10 months after the -23 basis point low was posted before starting to cut.

Market participants saw these bouts of flattening and deep curve inversion as evidence of how popular US Treasuries were as an investment, rather than a warning something bad was on the horizon coming. While we can sympathise in that view for a curve flattening, I would question that reasoning (strongly) for curve inversion. Though 2019 was slightly different, of course the yield curve did not predict Covid coming, though it did show clear warning of the danger that the Fed had over tightened while the economy began slowing.

Looking ahead, we expect to see bear steepening in 2s5s. This will be supported by tapering, which may well be accelerated, plus increasingly clear sticky inflation coupled with a Fed that remains gradualist (behind the curve) and reticent to move too fast in a dislocated post-pandemic world. Per Figure 3, we are watching pivotal resistance at 77.5 to 80 basis points which is multiyear trend line as well as the neckline of what could be construed as an inverted head and shoulders that would target a return towards 160 basis points again.

Figure 2. US 2s5s needs to be watched closely Figure 3. US 2s5s: 77.5-80bps is pivotal

Source: Aspen Graphics/Bloomberg Source: Aspen Graphics/Bloomberg

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Equities: Tightening Rotationby Alex Altmann, Mohammed Apabhai, Jimmy Conway

The key question for equities is how well the multiple can absorb a higher CPI regime. The Growth multiple appears most at risk and we therefore expect the rotation trade to find even firmer footing.

A strong earnings cycle, multiple expansion and record inflows have been powerful tail winds for equities since the start of the pandemic. However, with increasing pressure on central banks to tighten financial conditions, growing margin pressure and questions over how much of 2021’s earnings were ‘borrowed’ in 2020, the market is feeling very late cycle.

Tightening liquidity, contracting multiples. While earnings have risen meaningfully as the global economy has re-opened, extrapolating this year’s earnings growth into next year is problematic, given the high levels of pent-up demand from the earnings collapse in 2020 (Figure 4). Equally, equities have exhibited a very high correlation to the expansion of central bank balance sheets and real rates. If tightening of financial conditions leads to a reversal of these, the equity multiple will also be impacted. Economic expansion in the context of tapering should favor more cyclical geographies, especially those already trading on defensive valuations such as the UK and Europe.

As shown in Figure 5, very few other macro drivers have been as potent as central bank liquidity. Citi Equity Trading Strategy, globally is of the view that inflation pressures will continue to rise into next year (which is already being signalled by pockets of the equity market such as the style factors). While equities do offer some protection from inflation, it is important to note that growth stocks, which make up a large portion of US market cap outperform in periods of low real rates. Indeed, the correlation of the equity multiple to real rates has proved to be extremely high since 2018. Hence, if central banks do choose to tighten financial conditions and real rates rise, this will be a net negative at a headline market level.

Volatility is also likely to rise, especially in single names as investors start to question not only the appropriate multiple for a higher inflation environment but also the impact from ongoing input costs.

Figure 4. SPX Consensus EPS Current Year and Next Year Figure 5. Policy stimulus persists, keeps supply of assets low and prices high

Source: CETS, Bloomberg Source: CETS, Bloomberg



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Despite inflationary risks to headline indices, there are pockets of the market that do well in a ‘hotter’ economic environment. However, given their weighting within markets tends to be smaller than growth stocks (the two largest growth stocks in the Stoxx 50 are ~35% larger than the Euro banking sector) they may well outperform in a falling market.

Real rates are a real problem for equities. As can be seen in Figure 6, lower real rates are a driver of growth stocks’ outperformance, in this case tech. Higher real yields from a rise in nominal yields (taper) would reverse the post GFC trend of high multiple expansion – creating rotation within the market. Crucially, the performance of some parts of the rotation trade are dependent on higher nominals – so an expansion of real yields from a sudden drop in inflation expectations would see the same pattern of inflows into growth stocks.

The rotation debate has governed a large part of 2021, however it has failed to gain anything more than periodic sponsorship in terms of flows. As inflation, energy prices and capex all remain at high levels through 2022, the earnings momentum that has already been seen coming through in sectors like financials will drive a breakout in rotation.

In our view, key risks into 2022 beyond a tightening of financial conditions and a slow in the overall momentum of earnings include China growth, a turn in US retail investor sentiment, a shock candidate in the French Election and an increase in US tech regulation.

Figure 6. Average 12-month headline CPI (%YoY) vs SPX Trailing P/E

Source: Citi Equity Trading Strategy



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FX: Divergences Drive Dollar Higherby Ebrahim Rahbari, Calvin Tse, Lenny Jin

We expect growth divergence and policy divergence between the US and the Eurozone to push EURUSD lower and DXY higher into 2022, supported by French election risks.

The Great inflation and FX. We think the major macro trend into 2022 is the rise of inflation across many economies, linked to supply constraints, tight labor markets, stimulative policy, and corporate pricing behavior. The impact of inflation on FX depends on what drives inflation, the central bank reaction function and the extent of differences across economies. Overall, we favor currencies where inflation is driven more by robust growth and demand rather than supply constraints, and where the central bank is relatively more responsive to rising inflation. The Dollar ranks highly among the favored currencies vs alternative funders.

Growth divergences favor USD. The growth outlook into 2022 is subject to many cross-currents, but the outlook for the US is more benign than for, say, the Eurozone, as i) domestic demand remains robust with very loose monetary-fiscal conditions, ii) a relatively more muted negative impact from high energy prices and supply constraints in global manufacturing, iii) less sensitivity to the continued Chinese slowdown.

The return of central bank divergence. Citi Research US Economics expect the Fed to accelerate tapering plans before the start of the hiking cycle in June 2022. More broadly, the Fed will respond to any signs of higher inflation. Meanwhile, the ECB stresses that it is very unlikely to raise rates in 2022 or soon thereafter, as it remains haunted by premature tightening post-GFC. That points to a bottom in US real yields and wider US-EU yield differentials as we price more Fed tightening vs the ECB and other lagging G10 central banks (BoJ, SNB & RBA). Since policy divergence is linked to both economic divergence noted above and differential reaction functions, we expect it to pass through to FX and in particular weigh on EURUSD. Historically, DXY has also strengthened into a first rate hike – by 3.7% on average in the seven months into the first hike across 1994, 1999, 2004 and 2015.

EUR turn with the French election? We consider the 2015/16 template to be more relevant for the 2022 outlook than 2017 and French election concerns to be more muted vs 2017. But the Dollar could reverse trend as the year goes on, notably if Chinese & global growth sentiment bottom out and the French election passes as focal point for European risks. Moreover, the Dollar historically weakens out of the first Fed hike.

Figure 7. Historically, Dollar has strengthened into first US rate hike

Figure 8. Chinese growth and USD have been inversely related

Source: CitiFX Source: CitiFX, Bloomberg

https://www.citivelocity.com/fxcp/pages/wire/2129951/showHeader/true

https://www.citivelocity.com/t/r/eppublic/2ELA2



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by Stephen Leach

Emerging markets faces an uneven inflation landscape that will remain difficult to navigate. Central banks in high inflation regions have been pushed to hike but it remains unlikely to see those hikes translate into FX strength. CZK may remain an exception.

Inflation: Regional differences. Latin America has seen a surge in prices, Central and Eastern Europe has seen a boost but those in East Asia have been more controlled (Figure 9). Many factors can be cited for this difference: the severity of the 2020 recession and policy response; central bank credibility (or lack thereof); and inflation history. Two special cases to note: Turkey, where interest rates have been cut sharply at the same time as CPI has soared close to 20%, and Argentina, where inflation is above 50%.

Originally, the position of many EM countries was similar to that of the main industrial countries: the surge in inflation was ‘transitory’ and caused largely by supply-side disruptions resulting from the pandemic. As such, monetary policy changes were seen as ineffective and unwarranted.

Figure 9. EM regions face an uneven inflation landscape

Source: Wire services, central bank websites, Bloomberg, Refinitiv, Citi‘Inflation’ refers to the most recent consumer price inflation figure, October or September, which is the ‘highest since’…. IR response refers to the increase in benchmark interest rates by the respective central banks.



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But for countries in Latin America and CEE, this position became increasingly untenable as inflation continued to rise, often much more than expected, into more generalized pressures. The result has been a series of large interest rate increases across the two regions. Central banks maintain this was simply the process of policy normalization and rates remain at levels supporting economic expansion. However, nearly every central bank has now indicated that further hikes are likely; the emerging consensus in Brazil, which has the most aggressive policy response, suggests the process will continue well into 2022.

Within Asia and MEA, the pattern is quite different. While some countries are experiencing sharply higher PPI (e.g. China), for the most part, this has not fed through – at least yet – into CPI. Korea, Pakistan and Sri Lanka are the only Asian countries to hike rates – and then only by a minimal amount. Financial market stabilization drove Korea’s hike, while Sri Lanka is suffering from a major economic crisis (with inflation being a symptom rather than a cause) for which an even larger rate hike might be warranted. Singapore should be highlighted as the Monetary Authority executes policy through FX; tightened policy by shifting to an appreciating bias in its nominal effective exchange rate band.

As the stagflation debate has matured, it has been questioned whether some countries might be tightening excessively or at least raising interest rates to the point where GDP growth expectations are being downgraded. Again, Brazil stands out in this regard. The central bank’s latest weekly market survey lowered its forecast of 2022 GDP growth to just 1.0%. If confirmed, this would be Brazil’s weakest growth since the recession of 2015-2016, excluding of course the pandemic-related contraction of 4.1% in 2020.

Important questions: FX & interest rates. The longstanding rule in FX is that exchange rate changes dwarf any interest rate changes. Recent events reinforced this view: BRL appreciated through Q2 2021 alongside initial interest rate hikes and then depreciated despite an acceleration of policy tightening. Other factors are in play but this is not an isolated example.

All poses an important question for those countries in the process of raising interest rates, whether they are delivering at or above market expectations. For the most part, central banks on a policy tightening trajectory are being reactive, which is rarely a recipe for a stronger currency, though it may limit the extent of depreciation. They are responding to the threat from higher inflation rather than taking the view that higher interest rates are appropriate in a period of strong growth.

One potential exception is the Czech Republic, which has long recognized the correspondence between tighter monetary policy and a stronger exchange rate. An unexpected appreciation has on occasion obviated the need for higher interest rates. And it is one of the few countries where aggressive tightening has fed through into a stronger currency.

Tapering and the Fed: Less EM impact. In 2013, then-Fed Chair Ben Bernanke raised the issue of ‘tapering’ – that is, scaling back the level of bond purchases under the Fed’s quantitative easing program. The impact on EM was rapid and severe. The focus was centered on those countries with excessive current account deficits, most notably Brazil, India, Indonesia, South Africa and Turkey, though there was some argument at the time that Ukraine should be included in the list.

Reaction to the Fed’s ‘tapering’ announcement has been largely a non-event because it was widely discussed. But with respect to EM one can also make the case that current accounts are much less prevalent and that with interest rates at such low levels external financing is not a problem.

Today, none of the six countries listed above have current account deficits anywhere near the 5% of GDP level often seen as the cut-off for financing problems. In 2001, Brazil’s current account deficit is forecast at 0.2% of GDP, India at 0.8%, Indonesia at 0.1%, Turkey at 2.5% and Ukraine at 0.8%; South Africa is even forecast to post a surplus of 4.2%, its strongest performance in more than three decades as highlighted by Citi Research. Of course, Turkey is best considered as a special case, with the combination of rising inflation, one of the largest depreciations of any countries in the world this year and a series of cuts in official interest rates.

https://www.citivelocity.com/t/r/eppublic/2EtFH



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Credit: European IG – Not So Toughby Lee Street, Joe Faith

Conditions for IG spreads into 2022 appear tough on the face of it, given declining central bank support, credit yields at close to historic lows and M&A and capex funding liable to drive up supply. Yet the technical factors supporting credit – i.e. asset purchases from the ECB – could be more resilient than some expect.

Even after some recent weakness, € IG credit spreads are nearing 3y tights. While the volatile rates component has been a drag on total returns this year, even during the peak of the rates selloff, European IG credit has mostly resisted outflows, indicating the strength of the overall demand backdrop.

Those strong technicals have a lot to do with ECB support. Taking ECB corporate bond buying into account, the € IG nominal outstanding has failed to rise over the past year and a half (Figure 10). And both Fed and ECB asset purchases have driven a huge acceleration in excess reserves, supporting demand for fixed income, including credit (Figure 11).

Persistent inflation and monetary policy tightening are unsurprisingly at the top of the list of investor worries over the next year. Given how central bank buying (Figure 12) has supported valuations this year, its coming decline will present a challenge.

ECB QE tapering necessarily entails a reduction in government bond buying next year. But three quarters of ECB corporate bond buying comes from the APP, which looks set to be retained and likely expanded after March (Figure 13). Whether that will suffice to prop up ECB corporate bond buying is an open question.

Figure 10. € iBoxx IG Nominal Value, before and after ECB corporate bond buying, € tn

Figure 11. ECB Excess Reserves & Fed Reserves, local ccy tn

Source: Federal Reserve, ECB Source: Federal Reserve, ECB



Figure 12. Rolling 6m DM Central Bank Purchases, USDbn Figure 13. ECB CSPP & PEPP Corp Bond Purchases, EURbn

Source: Fed, ECB, BoJ and SNB data, Citi Research Source: ECB

Figure 14. US 10y Inflation Breakeven vs Real Yields (bp) vs US 10y Real Yield (%)

Figure 15. How is your company’s capex likely to change over the next 12m? (% net balance)

Source: Citi Velocity Charting Source: Deloitte European CFO Survey

Spread moves have become increasingly correlated with changes in (US) real yields in recent years, as the central bank liquidity-driven market regime has helped drive reach-for-yield behavior (Figure 14). Yet US real yields remain near record lows, despite extremely elevated inflation breakevens. In 2013, the last time the gap was similar, it was followed by a sharp rise in real yields; a similar move would likely pose substantial risks for credit spreads at their current tight levels.

IG corps’ dash-for-cash last year led to a fall in issuance needs in 2021. Yet with CFO surveys showing expectations of increasing capex, and the potential for rising M&A to drive up supply (Figure 15), 2022’s funding requirement might be bigger, another significant risk factor for next year.

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EM: Alpha in China, CEEMEA and LatAm Contingentby Asia – Manjesh Verma, Stella Li, Jiren Zhang

EM credit has had a sobering year with Asia returns sharply negative due to Asia HY selloff, LatAm credit experiencing a rough ride and CEEMEA credit returns barely positive. Looking ahead to 2022, the key alpha is in China HY, and with a pivotal few weeks ahead will be looking to add risk.

The worst is behind us. Asia credit has gone through one of the worst years on record with returns negative for both IG and HY. IG returns for 2021 are at -0.5% YTD with majority of weakness driven by rates, while HY returns are at -14% YTD with China HY returns at -30% YTD at the index level (Bloomberg Barclays).

We think that the worst case for China credit is behind us. Looking ahead, our outlook for 2022 would be highly dependent on the events into year end, but we will be looking to add risk in China HY. For reference, we note that average YTW for China HY stands at 25% and we would look to add with a view that yields need to normalise to 10-12% or lower for a normal functioning sector. IG spreads are tight across the region and are susceptible to rates led weakness. Similar to 2021, rates will once again likely be the defining factor for IG returns given that spreads are only about 25 bps wider vs. all time tights.

China HY. After a bruising year, we expect China HY to be the key long trade for 2022 as:

• Chinese regulators are expected to increase positive policy signals.

• The bulk of defaults will likely happen in Q4 2021and thereafter, the average credit quality of the sector should improve.

• Benchmark bonds are still trading at historically wide levels despite some pullback in early November;

• Even for distressed companies, we see increasing evidence that local authorities would intervene to accommodate an orderly operation to try and minimize unnecessary negative impact. Another factor we’ll watch out for is how soon the new issue market could open for BB credits and then for selective B credits.

Figure 16. Asia IG Sector Performance (Since Jan 2020, OAS)

Figure 17. Cross Regional IG Spreads (YTD, OAS)

Source: Citi Asia Credit, YieldBook Source: Citi



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Non-China HY. The Indonesia HY (index yield of 6.9%) has our attention, especially the property sector which is recovering with some coal names benefitting from record coal prices. India HY looks tight but will likely stay supported. We think Macau gaming names should recover as regulatory concerns ease in 2022. Philippines’ corporates tend to be lower beta and less noisy, as a result find risk-reward compelling for some corporates and financials. In the sovereign space, Sri Lanka continues to be the highest beta and we prefer the risk-reward on the lower Dollar priced part of the curve.

China IG. Overall most China IG names are close to historical tights with Tech names underperforming due to regulatory concerns. Sector specific policies have been the key focus in China IG space, ranging from the central State-owned enterprise (SOE) consolidation, implementation of the asset management rules to the antitrust and VIE structure regulation in TMT. In central SOEs space, most companies have benefited from the strong economic recovery while oil and gas, and commodity names’ were boosted by surging commodity prices.

We continue to see value in HAOHUA bonds with ongoing positive catalysts after the group restructuring and we think the spread compression between HAOHUA and other Tier 1 SOEs will continue. Financial names have been dominated by the implementation of the asset management rules and the potential negative impact from the rising defaults tied to China property sectors. We remain cautious on AT1s from mega banks given their tight valuations and these potential headwinds.

In the private owned enterprise (POE) space, we think the regulation tightening is set to slow down across TMT since the establishment of regulatory framework and major players like BABA, TENCNT and MEITUA have proactively adjusted their business. There should be less regulatory shocks in TMT sector in 2022 and our preferred pick in that space would be MEITUA. As the leading local services platform, we think it will be able to manage its current cash burn in new business initiatives. Outside TMT, we expect a recovering in profitability for the express delivery services, and like holding names such as SFHOLD and YUNDHL given their leading market position.

The China LGFV sector is a key area to look at given the increasing onshore credit headlines and declining land revenue for local government. We recommend staying away from LGFVs and regional SOEs with limited policy mandates such as QDHTCO, CONSON and ZHHFGR.

Non-China IG. Spreads look tight across the board, though there are exceptions like India IG where sovereign rating downgrade risk has dissipated after the recent Moody’s action. We think the core quasi sovereigns trade significantly wider to Thailand and Philippines quasi sovereigns which offer similar quality and ratings. We prefer names like EXIMBK, INRCIN, ONGCIN for example. We find pockets of value in Thai bank sub-debt and Malaysian gaming names while Korean and Singaporean IG corporates continue to be low beta, high quality credits with tight valuations and we think they will stay supported.



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by CEEMEA – Ayso Van Eysinga, Milena Ianeva

Sovereigns, defensive, and technically strong names, especially commodity exporters, remain in favor for CEEMEA HY markets. We also see selected corporate HY issuers in Sub-Saharan Africa and Ukraine offering the most attractive risk return profile, while Turkish banks and corporates risks are skewed to the downside, given valuations.

Sovereigns: Familiar Story. We doubt trends from 2021 will change into H1 2022. At a high level, the segment has fluctuated on macro whims as the world tackles with the post-Covid future. Countries with issuance plans, or with wobbly fundamentals, may continue to suffer unless we have a clearer macro-back drop. Commodity exporters, countries with lower financing needs and stronger ‘technicals’ should benefit.

The CEEMEA HY sovereigns segment will likely be split into three categories into 2022: technically strong (i.e., Kenya, Gabon), ‘beta’ (i.e., Nigeria, Egypt) and fallen angels (i.e. Ghana, Tunisia). Next year will be a big test for some of the serial issuers (from Egypt to Ghana), as market financing may not be as simple (or cheap) as in the past. Those countries with stronger relations as well as multilateral and bilateral partners may do better. On fundamentals, most of the Frontier will continue to improve in 2022 as fiscal deficits by and large close and growth strengthens. Broadly there is a decent amount of ‘value’ in the HY grouping relative to their IG peers. Fallen angels will be key to follow as how the likes of Ghana, Zambia, Tunisia and even Lebanon resolve their debt issues will offer a template for the asset class as we move on.

Corporates: Regional Safe Haven. In the corporate space, CEEMEA has been a relative safe-haven during 2021, especially in the HY segment. We expect this to continue, given favorable expectations for the commodity cycle and relatively strong corporate fundamentals. Inflation expectations, combined with concerns of a growth slowdown, not helped by supply chain disruptions, the commodity cycle and ESG will remain the key themes in 2022.

Figure 18. CEEMEA spreads YTD Figure 19. CEEMEA illiquids vs. HY Sov

Source: Citi Source: Citi



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by LatAm – Miguel Garcia de Onrubia, Ayoti Mittra, Albert Chang

LatAm Sovereign Credit returned -4.8% while spreads have widened 47bps YTD, driven largely by elections and downgrades. We expect a similar landscape in early 2022, where we remain constructive on the Dominican Republic and front-end Argentina, but selective on opportunities in Brazilian, Mexican, and Colombian corporate credits.

Sovereigns: Elections and reforms were the themes of 2021, as LatAm markets experienced volatility after Peru elected Pedro Castillo, Colombia lost its IG rating and Brazil’s government pivoted to higher social spending. The landscape for 2022 is similar, with elections and idiosyncratic risk dominating the region. In the low betas, Colombia goes to the polls in May with focus shifting to the leftist candidate. Brazil’s Presidential elections are also in the spotlight given former President Lula’s consistent lead in the polls.

In the higher beta and Central American space, Costa Rica holds Presidential elections in February, a run-off likely in April. El Salvador’s lack of an IMF program by Q1 2022 could raise the spectre of default. We see value in the Dominican Republic as the relative “safe space” given macro remains solid and the political/event calendar is clear – even though President Abinader has put tax reforms on hold. We are likewise constructive on front-end Argentina, where markets are close to pricing in the worst-case scenario of no-IMF; our base case remains that the government will close a deal here by March 2022.

Within corporates. We are focused on idiosyncratic opportunities nestled within their broader macro outlooks. Brazil’s looser fiscal stance, the upcoming election calendar, and a recent shift toward interventionist policies suggests heightened country risks for GSEs (Petrobras, Banco do Brasil, Eletrobras) in particular. There are some bright spots however, and we target select opportunities among high-quality commodity exporters (Vale, Suzano) and credits with large foreign operations (Gerdau, Braskem, Votorantim). We are also constructive on domestic airlines given the attractive yields on Gol & Azul in the context of recovering travel and improved liquidity runways. Meanwhile in Mexico, AMLO’s electricity reforms are likely to take centre stage, with Congressional deliberations here slotted for the April-June 2022 timeframe. This should uniquely benefit CFE given their implied monopoly in the sector despite boding poorly for IPPs like Tierra Mojada.

Within the Andes, Ecopetrol is likely to benefit from the upside in oil prices coupled with new ISA contributions, which should drive continued deleveraging of the combined entity. Among the smaller producers, Gran Tierra’s balance sheet should continue benefitting from a constructive crude outlook, while we see the highest upside potential in Frontera and its potentially transformational Guyana prospects. In Peru, political overhangs remain for Hunt Oil as the Camisea renegotiations are likely to materialize in 2022. Similarly, Peru LNG will be closely monitored as it enters its waning years to demonstrate FCF potential before its (currently untenable) 2024 amortization. We are keeping an eye on the Castillo administration’s tax overhaul for copper miners as well as the broader social sentiment around new mining concessions, with a specific focus on Southern Copper. Our preferred pick in this space is the Glencore-controlled zinc-miner Volcan.

Figure 20. Election Calendar (2022)

Source: Citi

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