Weekly Market Trends
Preparing for a Policy Pivot With Preferreds
Inflation seems to have finally begun its retreat, and with it, the Federal Reserve (Fed) looks set to slow rate hikes. If policy does indeed pivot, preferred securities may now be sitting at an attractive entry point.
This article was written with contributions from Bartlomiej Szczurek. Bart is a Research Analyst on the SPDR Americas Research Team.
Most major equity indices edged lower this past week after a stronger-than-expected Producer Price Index (PPI) reading in the US. China ended the week 6.8% higher as the economy reopens after easing its’ COVID policy. Oil prices dipped more than 11% following a Keystone pipeline spill on Wednesday.1 The timeline to clean up the spill and resume service remains unknown.
Tracking Inflation’s Bumpy Path
Core PPI inflation came in at 6.2%, higher than the expected 5.9%, suggesting that the glide path from peak inflation may be bumpier than hoped. Yet US short-term inflation expectations unexpectedly declined to 4.6%, its lowest level in more than a year.2 Meanwhile, CPI data released on Tuesday revealed that headline CPI increased less than expected, with a 7.1% year-on-year gain.3
As inflation seems to have finally begun to retreat, as was widely expected, the Federal Reserve (Fed) slowed their rate hikes to just 50 basis points (bps) at the meeting this week.
COVID-19 May Overwhelm China Again
China faces a daunting task after significantly relaxing its’ zero-Covid policy. As restrictions ease, infections seem set to surge and deaths from the virus may surpass two million.4
ECB Tightens Loan Program
Euro-area banks will return $472 billion in cheap loans to the European Central Bank (ECB).5 The loans were initially used to keep credit flowing to households and businesses during pandemic, but the terms of the program have been tightened in an effort to combat double-digit inflation. The repayment, set for December, will shrink the amount of outstanding loans by 25%.
The ECB is expected to slow the pace of rate hikes soon, with quantitative tightening likely to begin in Q1 2023.
A Preferred Policy Pivot Play
Preferred securities were steadfastly out of favor this year, as rate hikes and sluggish growth weighed on both their bond- and stock-like nature. Yet, based on the forward-looking Fed effective rate, nearly 80% of the tightening has been completed,6 indicating that the negative impact on bonds may be slowing, and broader market sentiment could improve if there is a policy pivot.
Preferreds, therefore, offer a deeply discounted investment-grade-rated yield opportunity that may be able to participate in any risk aversion reversal predicated on any potential policy pivot that tempers central bank aggressiveness. This attractive entry point provides a bit of a backstop and balances the potential risks that the full pivot may not come as soon, or may not be as substantial as many expect.
Preferred Securities: An Attractive Entry Point?
Implementation Idea: SPDR® ICE Preferred Securities ETF (PSK)
Given their hybrid nature, preferred securities were doubly impacted by duration-induced price declines and the impairment in equity growth and sentiment — falling by over 15% in 2022.7 The steep decline, however, pushed the yield on preferreds to over 6% and the average price on the securities down to the mid-80’s.8 This is the first time, outside of the brief COVID crash timeframe, that preferreds were trading at this large of a discount to par.
The SPDR ICE Preferred Securities ETF (PSK) seeks to provide exposure to this investment-grade-rated hybrid market, a segment that now offers a yield above that of any sector, credit quality, or rating band in the global investment-grade bond market.9
PSK Standard Performance as of September 30, 2022
