10th March 2016

20:20 Vision

FTSE 100
6,146, +21
9,773, +30
S&P 500
1,989, +10
iTraxx Main
91bp, -1bp
iTraxx X-Over Index
373bp, -6bp
10 Yr Bund
0.24%, +6bp
iBoxx Corp IG
B+175bp, -0.5bp 
iBoxx Corp HY Index
B+592bp, -4bp
10 Yr US T-Bond
1.89%, +6bp

(Not) a whole lotta shaking’ going’ on… With the ECB looming, few were ever going to get excited with respect to positioning and risk-taking immediately before any announcement. It was a case of every man (asset class) for himself, with no clear trend established between them. That’s how the day started, but an upbeat tone prevailed and we saw a decent rally in risk assets. So what do we want from the ECB? As a minimum, 10bp off the deposit rate and €10bn added to the monthly asset purchase programme. To excite us and get us into the mood to add risk and rally good next week, we want 20bp lopped off the deposit rate and €20bn added to the asset purchase programme. That would invigorate the markets and see to it that the first quarter recovers the rest of the lost performance from January and February, and set us up for an intriguing second quarter. With data showing a clear downside to risks, there should be enough there to keep the hawks (particularly Germany) at bay and finally let the ECB show that it has some teeth. However, and as ever with consensus politics, the ECB will likely fall short on the 20:20, and either give us the 10:10 or – more likely – something in between. We will be none the wiser for it and if, as we expect, the data continues to disappoint, we will be clamouring for more post-haste. In the meantime, who would have believed oil prices would be up at $40 per barrel given that they were $26 back in mid-January? Or that equity indices would be down in the low single-digit losses YTD after being as much as 18% lower? Or that the corporate bond market would maintain a positive total return through the year so far despite spreads being wider by 35bp at one stage? That points to some recovery for the oil and equity sectors, and highlights the inherent stability and attractiveness of the IG corporate bond market.

Default rate to tick higher, but stay at low levels… Moody’s released comments that it expects the default rate to rise to 4.7% over the next 12 months and surpass the average established since 2010. That might be the case – and it’s a good headline – but most of the defaults are arising in the US and Asia and are in the commodity-related sector. We think the rate will stay at or below the long-term average in Europe for the next 12 months, but thereafter the default situation will increasingly depend on funding conditions for HY entities and the state of the eurozone economy. For sure, there is no onerous “wall of redemptions” which need refinancing in 2016 and 2017, but there are potential problems being stored up for 2018 and beyond. Below we show the European corporate monthly speculative default rate, as supplied by S&P, going back to 2010. European HY still looks like good value at current levels at this point and we would retain exposure to it, albeit in the double-B sector, liquidity permitting. Certainly, the transmission risk for double-B entities over a 3 to 5-year period are low and manageable.

European speculative grade default rate

Screen Shot 2016-03-09 at 17.47.21

Primary revving up… Ferrari issued its inaugural €500m deal in a 7-year maturity (unrated, but priced as a low IG issue), while RCI Banque also clipped €500m in a 3-year FRN format. The Ferrari deal was over 4x subscribed. Pemex issued a dual tranche deal totalling €2.25bn in what looked like a steal for investors. The company might be IG rated, but they’re tarnished with the EM tag, and that means they have to pay-up. The 3-year was priced at midswaps+395bp and the 5-year at midswaps+495bp, with final books of around €6bn. The deal which probably captured the imagination though was the 3-tranche effort from Berkshire Hathaway. Following hot on the heels of the huge dollar transaction on Tuesday ($9bn over seven tranches), they were over here taking down €2.75bn in 4, 8 and 12-year funding. It caps a very good week so far for issuance (almost €7bn in non-financial IG), pre-ECB, and better than what we thought otherwise might have been the case.

Over to you Mr Draghi, time to deliver… We closed out Wednesday on a mixed note after the earlier strong rally fizzled out. It was as if the market suddenly got cold feet! Having been well over 1% for most of the session, European stocks ended just a small up as the nerves started to fray. Oil had no such qualms and settled on the order of 3% higher with Brent at around $41 per barrel. Government bonds were materially weaker, with Gilts, Treasuries and Bunds giving up all the previous day’s gains. The 10-year Bund yield closed at 0.24% which was last week’s high point having backed up 6bp in the session, as did the 10-year UST to 1.89%. The periphery actually outperformed with 10-year BTPs and Bonos now yielding 1.41% and 1.56%, respectively, and a tad lower in the session. In the corporate bond market, the focus was squarely on the big primary issuance, so secondary was subdued and just limped along. We closed out a touch better with IG corporates as measured by the Markit iBoxx index at B+175bp while HY risk was better leaving the index at B+592bp (-4bp). The indices closed better too at 91bp and 373bp for Main and X-over, respectively.

We will know soon enough, 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.