Market Awareness interview questions

APP and PEPP continue to run down, with no reinvestment of redemptions. That structurally removes a very large, price-insensitive buyer from the market - the ECB also bought corporate bonds under the CSPP. Two consequences. First, the private sector has to absorb a materially higher net volume, in both government and corporate bonds. Second - and I think this matters more - the market is now more sensitive again to supply and to flows, because the buffer is gone. A supply pile-up in one week feeds through to premiums more strongly today than it did during the purchase programmes.

Through three channels. Energy and inflation: the disruption around the Strait of Hormuz has pushed oil sharply higher - Brent is around a third above where it was a year ago and has traded above $100 at points. That drives inflation, pushes central banks towards tightening and therefore lifts the whole level of yields. That's the most important channel, and it works against bonds, not for them. Risk aversion: in acute escalations there is a flight to quality - Bunds and Treasuries bid, credit spreads wider. European IG spreads widened noticeably in the spring for that reason and have largely retraced since. Volatility and issuance windows: that's the channel that affects us most directly. High rate volatility makes investors more price sensitive, books get thinner, new issue premiums rise - in July to the highest level of the year - and windows narrow. Issuers are currently accepting the higher premium rather than waiting. The interesting point is that secondary spreads don't reflect any of this: they're historically tight. The stress shows up in the primary market, not in the secondary market.

Because the second half of the year is compressed in the primary market. August is seasonally effectively dead - many investors aren't staffed and nobody wants to issue into a thin book. From September the market reopens and then runs very densely until late November, because after that the year-end comes: from December investors' books close, balance sheet dates approach, and nobody issues unless they have to. Which means: anyone who still wants to fund in Q4 has to do it in October and November.

Because of energy, not demand. The Middle East conflict and the disruption around the Strait of Hormuz pushed oil and gas sharply higher. The market then repriced inflation risk far more than growth risk. In July the ECB made clear that energy prices remain highly volatile, sit above pre-conflict levels, and that the full inflationary impact of the energy shock has yet to play out. What it is watching particularly are second-round effects - that is, whether the energy shock embeds itself in wages and services prices.

I'd name two, and I think the second is underrated. First, a renewed escalation around the Strait of Hormuz. Negotiations are running but they're stalling. A failure would mean oil materially higher, inflation expectations higher, central banks more restrictive - and this time without the buffer that a low level of yields used to provide. Second, valuation in credit itself. Spreads are tight, measured against their own history very tight, and they price in little tolerance for error. If a shock came - macro or idiosyncratic - the path down is longer than the path up. That's not a forecast, but it is an asymmetry. What I don't see as an acute risk is credit quality itself: the stress at the moment is in execution and in premiums, not in defaults or downgrades.