Systematic Credit and Equity G-250 Trading Indicators for May 20, 2025

Credit Ratings Downgrades

Good Morning: Does Moody's downgrade of the US to Aa1 have lingering effects? Not really. If only corporate bonds reacted as calmly as USTs did to their credit rating change. We observed corporate bond spreads widening by +2 to +3 basis points and 10Y UST yields dropping nearly half a point, but the effect was short-lived.

The broader focus remains on US equity prices, which only impact our credit trading model to the extent that corporate bond spreads correlate with equity index pricing. While this correlation holds at the index level, many statistical relationships between individual 10-year corporate credit spreads and US investment-grade (IG) credit spreads have broken down. Based on 35 years of data, the lack of correlation between individual issuer equity prices and credit spreads—both for corporates and sovereign bonds versus local equity indices—can persist for up to six months. However, the correlation between equities, sovereign bonds, and corporate issuers remains statistically significant over time.

This brings us to the inflation outlook, as reflected by the world's largest corporate debt issuers, US survey and outlook data, and yesterday's Conference Board Leading Economic Index for April, which reported a striking -1.0% decline. How significant is this? Outside of the COVID-driven US economic shutdown in March 2023 (-1.3%), this is a notable drop. While US equity prices have rebounded since last month, only two components in the report were non-negative: non-defense capital goods orders (+0.3%) and the Leading Credit Index (+0.2%).

Our perspective differs slightly. Historically, higher inflation has driven higher interest rates, which, combined with asset allocations shifting away from USD-denominated assets, leads to lower US earnings, P/E ratios, and wider credit spreads. So far, we've only seen capital flowing into non-USD-denominated assets in the corporate bond market. This is evident in the increased issuance of non-dollar corporate debt by the world's largest issuers and lower trading volumes in US IG bonds. While reported inflation, higher interest rates, and lower P/E ratios have not yet fully materialized, lower earnings guidance for 2025 and 2026 has been notable in most non-tech sectors.

Inflation Readings and Interest Rate Calls

Additional survey data will be released on Wednesday, including PMI data and the Kansas City Fed Manufacturing Activity Index. No further May data will be available until the ISM Prices Paid Index for May is reported on June 4.

The 10-year UST remains the top-performing government bond globally in 2025, outperformed only by Brazil.

Earnings Season

Earnings reports are still pending from Medtronic (MDT), British Telecom (BT), Toronto-Dominion Bank (TD), Home Depot (HD), Lowe's (LOW), Vodafone (VOD), and AutoZone (AZO, a non-G-250 issuer). These reports should provide further clarity on the US economy's direction.

The world's largest debt issuers are not significantly increasing financial leverage overall, though leverage trends vary by sector.

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US Financial Institutions

• The 22 major US financial institutions reporting Q1 2025 results show:

• $32 billion in balance sheet liquidity used for shareholder payouts or reallocated to trading assets.

• $100 billion in total debt added in Q1 2025.

• Over the past 12 months, a $323 billion reduction in cash and short-term investments and an $86 billion increase in debt.

• Liquidity-to-debt ratios remain comfortable, with $2 trillion in liquidity against $2.8 trillion in debt.

• Deposits total $11.3 trillion, including $1.3 trillion from non-US depositors.

• Shareholder payouts reached $48.5 billion in Q1 2025, up 36% year-over-year.

These trends indicate that banks must either accelerate revenue and cash flow growth or moderate dividend and share repurchase programs.

Monday's US IG Credit Trading:

USD trading volumes were 2% below average, with end users purchasing $1.6 billion in IG credit. Financials accounted for over 30% of purchases, with Goldman Sachs (GS), Oracle (ORCL), and Warner Bros. Discovery (WBD) being the most net-bought issuers.

The US CDX index was unchanged at 55 basis points, while US IG cash spreads tightened by up to 2 basis points, led by Autos and Industrials. Financials (domestic and Yankee bonds) underperformed.

Attractive trading sectors

Long Opportunities: Single A and BBB UK Banks ($104 billion of market capital/68 bonds).

Short Opportunities: US Big 6 Banks, all ratings ($632.3 billion in overvalued market capital, 238 bonds, 50 short indicators).

Single A and BBB TMT ($269.4 billion in overvalued market capital, 154 bonds, 40 short indicators).

Single A and BBB Consumer ($137 billion in overvalued market capital, 106 bonds, 38 short indicators).

Issuer News Monday

Pfizer (PFE) will pay $1.25 billion upfront to license an experimental cancer drug with 3SBio eligible for up to $4.8 billion in downstream fees if the drug hits all milestones.

U.S. IG Credit Valuation and Spreads

US investment-grade (IG) credit is currently "slightly overvalued" but remains significantly cheaper than its trading levels over the past two years. Credit spreads are closer to their 52-week widest levels (April 10, 2025) than to their 52-week and 5-year tightest levels (November 12, 2024).

Global Equity Correlation to IG Credit Spreads

Increased leverage on large US balance sheets, with approximately half allocated to shareholder returns, has caused a notable lag in the correlation between US equities (approximately +5% return year-over-year) and US IG credit spreads (approximately 30 basis points wider year-over-year).

New Supply / Bond Maturities / Credit Fund outflows for May

Monday's US new bond issuance stood out, particularly after Moody's US downgrade on Friday, which drove significant market movement before the market opened. Six of the world's largest issuers sold debt in Europe, while smaller transactions from Qualcomm (QCOM), Rabobank (RABOBK), and Handelsbanken (SHBASS) were attractively priced given the market sentiment and traded strongly in the grey market.

Deal of the Day

Today's standout opportunity is the $1.75 billion Credit AG 6nc5 bond, priced at a new issue spread with significant potential to tighten, according to our trading model.

As noted yesterday, five issuers sold the equivalent of €7.3 billion in bonds, while the four issuers mentioned above issued $6.25 billion. Since the earnings season began on April 14, approximately $170 billion in non-Big 6 bank bonds have been raised in USD and European markets. The U.S. share, at roughly 55% of the total supply from the world's largest issuer over the past six weeks, is near a 10-year low. This reflects increased capital formation outside the U.S., likely driven by uncertainty surrounding trade discussions.

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Systematic Trading Model Indicators and Trading Strategy - Tuesday

The most significant long trading opportunities are in TMT and UK and European banks. The primary short trading opportunities lie in BBB-rated auto, single-A and BBB industrials, and Big 6 banks. However, long opportunities require wider spreads, and attractive short opportunities need tighter trading levels to be actionable.

Of the 347 bonds trading at extreme levels (long and short), the 269 attractive short trading indicators account for 77.5% of the total. However, the current number of short indicators is 37% below the historical average. Meanwhile, de-leveraging issuers, such as Credit Agricole (ACAFP), have issued bonds at attractive levels for long positions.

Systematic Trading Strategy for Tuesday May 20

The model advises selling long positions when they reach the "avoid trading" level and delaying larger short positions until the number of attractive short positions reaches 400.

Long Positions

Focus on attractive bonds (or new supply) from issuers that have already reported earnings. For fixed-coupon bonds, prioritize issues with a size exceeding $1 billion.

Short Positions

Target issuer bonds trading within 20% of their 52-week tight spread, where the underlying company is releveraging its balance sheet.

Systematic Credit Indicators

Systematic credit trading employs defined back-tested trading processes and portfolio construction algorithms based on issuer reported and market trading parameters. This clarity differentiates them from discretionary approaches, offering replicable and auditable methods. We target ±5 basis points of credit spread movement in minimal trading days, balancing return maximization with volatility risk.

Most Recent Model Trading Indicators

The Bank of America (A2/A-) BAC Float 05/09/29, and Toyota (A1/A+) TOYOTA 4.8 05/15/30 both hit their reached their avoid trading level Monday. The new Credit Agricole (A3/A-) SNP ACAFP 5.222 05/27/31 an attracitve new issue is the model Indicator we publish this AM.

Friday Sample Trading Indicator Credit Spread Movement

Since January 4 of this year we have published 103 trading opportunities or about 1% of the total Indicators from our systematic trading model

• 55 of 76 attractive long indicators have reached their avoid-trading level and tightened by (-9.1bp) on average

• 24 of 27 attractive short trading indicators have reached their avoid-trading level and widened by (+5.3 bp) on average.

• The remaining 21 long indicators credit spreads have widened by (+3.6bp) on average.

• Across all 103 indicators, credit spread movement has been +/- 5.36 bp in the direction of the those indicators.

Earnings reports from last week

Enterprise Products (EPD, A3/A-)

• EPD filed its 10Q On the 10^th of the month and candidly, we missed it. .

• Financial Position: Post- Pinon Mdstream acquistion in late 2024, EPD's bealance sheet has not yet begun to lose net debt which is now $31.5 billion.

• Model Trading Indicators: Our credit trading model views 6 of the current 25 USD EPD secondary bonds as attractive short trading Indicators. With the EPD 2.8 01/31/30 and the EPD 4.85 01/31/34 the most attractive. Our trading model views EPD equity as attractive at Monday's closing price.

Disclaimer - This report is not intended as, and does not constitute an offer, or a solicitation to buy or sell any securities or financial instruments. All data, levels, opinions, and representations herein are provided for informational purposes only and should not be relied upon for making investment decisions. Past performance is not indicative of future results. The authors of this report assume no liability for losses or damages arising from the use of this information. Investors should consult with a qualified financial advisor before making any investment decisions. The information in this report is based on sources believed to be reliable, but no guarantee is made as to its accuracy, completeness, or timeliness.