4th June 2020

⤴ It’s a swoosh, a W, an L… No: Markets pricing in a V

iTraxx Main

64.obp, -0.5bp

iTraxx X-Over

369.8bp, -0.8bp

🇩🇪 10 Yr Bund

-0.32%, +3bp

iBoxx Corp IG

B+161.7bp, -8bp

iBoxx Corp HY

B+531bp, -20bp

🇺🇸 10 Yr US T-Bond

0.80%, +4bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”24″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”25″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”26″]

Macro mood music upbeat…

After hitting the slightest of bumps, the demand for corporate debt has increased again. Markedly, at that. We had observed that new deal subscriptions and final pricing (versus the initial guidance) had withered during the last couple or so weeks of May, from more effusive levels. However, primary market activity over the last week has seen interest (typically demand at 10x or more and final prices up to 70-80bp tighter versus IPT) ratchet to the heady levels seen through April/early May – if not exceed them.

This has come as a function of improved confidence in the economic recovery dynamic – in no small part helped also from the headline arising from public money going into bail-out national champions (Lufthansa and Renault for example). Some are always just too big to fail. Taking in the rally in German equities in particular, where over 2,000 points have been added to the Dax in a month (+20%), then surely a V-shaped recovery is being priced by markets.

Rising equities always helps. The plethora of stimulus packages are not just stemming the downside and underpinning a recovery, they are going to turbo-boost the charge higher. In the UK, for example, the final Brexit/EU deadline is in view and further measures to underpin growth will come as concerns of a no-deal exit rise.

Credit spreads are on a tightening charge and new deals are mostly performing on the break. Of course, cash is flowing into corporate bond funds and it is looking for paper. The secondary market squeeze is in full flow.

It’s not gone unnoticed, though, that the level of deal flow seems to have slowed. We are still likely going to get an above-average level of IG non-financial issuance this month and likely that will be the case in July and August. That will support the notion of hugely oversubscribed books, allow syndicates to ram final pricing tighter versus the opening guidance and play into the ‘deals work at these levels’ narrative.

Primary market pricing mind games rise

We would argue that there should have been little by way of price discovery in the exaggerated initial guidance levels, but to lop 60bp, 70bp or even 80bp off pricing smacks of either a poor market understanding by the banks or a broad expectation by bank syndicates, borrowers and investors alike to keep playing the game.

The deal flow in Wednesday’s session, for example, took in Prologis€500m in a 12-year at midswaps+165bp where books in excess of €7.5bn saw final pricing of the deal some 65bp tighter than the initial mumble. Dutch utility group Alliander also issued €500m in a no-grow 10-year priced at midswaps+45bp and even this was 50bp inside the initial talk, on books over €5.6bn. Danone took €800m in a 9-year maturity at midswaps+50bp and 45bp was knocked off the initial guidance, with books just shy of €5bn.

Thursday was altogether a quieter day, but there were a few issues in the market. Engie issued €750m in a 7-year at midswaps+65bp, which was a ‘generic’ 35bp inside the opening guidance off an equally very ‘generic’ €2.7bn book! Then we had Credit Mutuel Arkea issue a senior non-preferred for €750m in a 9NC8 social Covid-19 bond at midswaps+150bp (-30bp versus IPT).

This week’s IG deals

Liquidity trumps Main Street unrest

Elsewhere, the economic data in the form of PMIs across Europe and the US suggest we are off the bottom in both the service and manufacturing sectors. Other data will send the same message as and when – retail sales in May across the Eurozone for instance were better than expected, albeit still at depressed levels.

In addition, the easing of lockdowns is not resulting in a pick-up in Covid-19 infections/deaths. Main Street unrest is being ignored. Overall investor confidence in macro is improving.

The ECB dominated the day and, in their own way, tried to get ahead of the curve. They left rates unchanged but expanded the bond-buying programme by more than expected  – to €1.35trn (+€600bn) – and extended it to June 2021, with maturing proceeds to be reinvested until at least the of 2022. There’s still a big battle potentially looming with the German constitutional court, but that obviously doesn’t worry them with Lagarde suggesting the ECB operated under the jurisdiction of the ECJ.

The ECB acknowledged the downside risks to the current slump in growth, the difficult recovery trajectory (laboured/tepid at best) and the deflationary threat to the region. For sure, they have left the door open to further future action.

The forecast for GDP growth in 2020 was -8.7% with a recovery of 5.2% in 2021. For inflation, they are looking at a rate of just 0.3% in 2020, 0.8% in 2021 and revised lower to 1.3% in 2022 – the latter being a medium-term target well short of the 2% target rate. The risks to all those forecasts were to the downside.

Anyway, the expansion of the PEPP saw that rates rallied across the periphery, with the 10-year BTP heading to yield 1.40% (-15bp) but we saw little change in the core to start. Then we had some weakness. Bunds were left to yield -0.31% (+3bp), for example. In the UK, the 10-year Gilt yield popped higher – also to 0.31% (+4bp).

Equities have had a roaring week. They gave some back on Thursday, but the Dax has still added in the region of 7.5% this week, and the S&P is around 280 points off its February record high! And not far from being flat year to date (just 100 points or so to go). Who would have thought?

In synthetic credit, the iTraxx market protection levels effectively halted their tightening trend although the market was better offered for choice. Main is now at 64bp (-0.5bp) and X-Over at 369.8bp (-0.8bp), with the ratio between them unchanged at 5.75x.

As for the cash market, it continued to squeeze. The crunch tighter in spreads saw the IG iBoxx index 7bp tighter at B+158.3bp (against 8bp on Wednesday). High beta clearly tightened more, the high yield index 13bp tighter at B+518bp (some 57bp tighter this week). The CoCo index dropped through B+700bp to B+666bp (-34bp).

Have a good day.

Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.