4th March 2018

America unhinged

iTraxx Main

54.6bp, +1.2bp

iTraxx X-Over

273.1bp, +5.2bp

10 Yr Bund

0.64%, unchanged

iBoxx Corp IG

B+92.8bp, +1.6bp

iBoxx Corp HY

B+313.7bp, +2.8bp

10 Yr US T-Bond

2.87%, +7bp

FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] S&P 500 [wp_live_scraper id=”10″], [wp_live_scraper id=”11″]

It’s the stuff of Hollywood…

Just like in most Hollywood movies, there’s the bad guy and the good guy. And, of course, the US wins the day. We’re now gripped by the impending US steel import tariffs and what they might mean for global trade. The markets are all a-tither.

How to trade it? Stocks down and then up. Europe was trashed while the US staged a late recovery to close smartly in the black. Rates moved lower, and then higher only to close flat in Europe and significantly up in the US as risk markets closed with positive tone. Judging by those end of week moves, US risk markets are winning out. Kim Jong-un, Putin, the Italian elections, Brexit, rising levels of inflation… nay, the biggest event-risk besetting the market outlook remains President Trump!

So all the uncertainty arises from the promised imposition of steel and aluminium import tariffs slated for this week (no point in wasting time), in order to protect the US steel industry, as part of his America First election promise. Without arguing about the relative merits of such a move, the potential tit-for-tat measures are substantial and threaten to plunge to world into a most unwelcome trade war.

Juncker has already sounded off on bourbon, Harleys… and Levis jeans, with Trump threatening import tariffs on EU exports to the US of autos. The EU will have to pick its fight with the US with a little more care than it currently is with the UK. We would think that there is easily enough mileage in the rhetoric around it such that risk assets will stay volatile for a considerable period, but that the near-term reality has US risk asset potentially offering better upside versus non-US markets as global markets adjust, fret and perhaps trade lower into the uncertainty.

Never will the old saying – about the markets hating uncertainty, be more appropriate. There was initially a rush for safe-haven assets, leaving government bond markets with bit of a boost. Levels like 3.0% on the 10-year US Treasury yield or 0.80% on the equivalent Bund yield suddenly looked more distant, but the 10-year Treasury rose to 2.87% into the close – higher inflation, dumping of Treasuries by foreigners (?). The reasonable expectation of a 3,000 level as a year-end target for the S&P500 index (currently at around 2,690, and versus record high a few weeks ago of 2,872) was looking increasingly like a tough ask as well, but might just get there if US industry is boosted – notwithstanding how it might be impacted by any broadening of the import tariffs.

The headline and other risks associated with those upcoming tariffs, as well as some focus on Theresa May’s Brexit speech gripped in Friday’s session. It meant the primary credit markets were closed, while secondary was just marked a little wider as investors pondered what the net effect might be of a global trade war. US stocks initially took a 1%+ tumble lower before they recovered hard into the close, but the Dax was lower by over 2%. The German stock index is now off by over 1,000 points this year at 11,914, or -7.9% YTD. Volatility rose, the Vix index trading in a 19 – 26% range before settling 3-points lower at 19.6% at the close.

Eurosceptic – or anti-Establishment government for Italy?

The big event in Europe was Sunday’s Italian election (result unknown as at the time of writing) and ought to have been the main focus for the weekend. Here, everything might change – and yet nothing will, probably. That is, we will likely have a non-centrist party gaining the most votes, but within the context of yet another a coalition government. We’re going to be testing Europe’s appetite for populist movements and/or a lurch to the right.

The permutations boggle. The two populist parties come in the form of the anti-establishment Five Star Movement which is due to be the single biggest party according the polls, and the far-right but much smaller “Italians first” La Lega party (running in fourth position). The centre-right coalition – which includes Berlusconi’s Forza Italia party (yes, he’s potentially back) is out in front, while the ruling Democrats are fading rapidly (in the polls anyway). The 30% or so ‘undecideds’ will decide.

Secondary to that, in a sense, was Brexit. Prime Minister May’s long-awaited speech delivered on Friday seemed to hit all the right notes. In our view, it cut a tone which was measured, encompassing, pragmatic and conciliatory – the EU Commission now needs to respond in similar fashion, we feel, in order to move the whole issue forward without the bitterness of previous exchanges. The EU will likely respond on Monday.

At least the Germans have a government in place after the centre-left Social Democrat Party finally agreed in favour of a coalition deal with Merkel’s Christian Democrats.

Equity volatility leaves markets defensive

We closed out last week gripped by volatile markets. As usual, it all centred on the equity markets as investors pondered the imposition of an import tariff regime (on steel and aluminium for now), and how they might impact the relative attraction of different markets. For sure, the fear of dumping of steel products in non-US markets will necessarily or potentially force a global tariff regime (protectionist measures elsewhere) with the result that global trade becomes less so, as protectionist measures feed off each other. It looks like we might just have found our unforeseen event risk which scuppers hopes of a higher concerted global growth movement for 2018. Relative value might just be making a comeback.

Anyway, the other news flow in the session wasn’t necessarily bright either. German retail sales declined 0.7% in January versus expectations of a 0.9% rise, while household consumption in Q4/2017 in Italy failed to perk up despite GDP running at a 1.6% annual rate.

So we closed with Gilt yields unchanged at 1.47% and 10-year Bunds yielding an unchanged 0.64% (were down at 0.62%). The Dax lost 2.3% as mentioned earlier as most major markets lost 2% or more in Europe.

The Markit iBoxx IG cash index closed 1.6bp higher at B+92.8bp, which was almost 3bp higher in the week. The HY index was left at B+313.7bp (+2.8bp) while that was 4bp for the week – a moderate move for the moment on reflection. That might be worse after Monday. The CoCo index was relatively stable too, at B+339bp – which left it 13bp tighter in the week. The iTraxx indices saw Main up at 54.6bp (+1.2bp) at the close and X-Over 5.2bp higher at 273.1bp.

This week, we end with the US non-farm payroll report for February (205k consensus). Before that, the ECB meeting is the pick of the slew of central bank meetings, and we have the result of the Italian election early on Monday. We suspect though, that the ramifications of the imposition of the steel tariffs will linger and likely leave us with particularly uncertain and volatile markets. Credit primary might be a big victim as hopes for a pick-up in much-needed issuance are dashed as broad market confidence is eroded.

Have a good day.

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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.