1st November 2017

As good as it gets?

iTraxx Main

49.7bp, -0.3bp

iTraxx X-Over

223.7bp, -1.5bp

10 Yr Bund

0.37%, +1bp

iBoxx Corp IG

B+95.9bp, -1.9bp

iBoxx Corp HY

B+257.8bp, -1.5bp

10 Yr US T-Bond

2.37%, unchanged

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″]

No, there’s life in the old dog yet…

There was little distraction from the Fed’s rate decision in a session where European markets rallied hard. Equities gained over 1% in some cases, iTraxx Main Series 28 dropped through 50bp, cash credit squeezed some more and rate markets were fairly stable. That’s about as good a start to the month as we could have expected. With oil prices on the up and the energy sector getting a huge boost from it, it has not been forgotten on us that it means the shale producers will be pumping away and default rates in that industry will be declining. Why does that matter? Confidence. Confidence in US high yield and that will filter through to sustaining the bid here for what has become a very rich asset class (in historical terms).

After all, HY spreads are at record tights, index yields at record lows and the cost of funding for HY rated corporates has never been so cheap. There’s no stopping the demand for higher yielding assets while market rates remain anchored and seemingly refuse to burst higher. Equities might be up 15% or more this year (DAX, S&P500 and Dow, for example), but the high yield market has exceeded 6%, CoCos 17% and even IG returns are approaching 3%. That’s great returns for fixed income.

We could have expected a subdued session, heading into the concluding session of the FOMC decision as well as parts of Europe closed for a holiday too. Well, equities ignored that, opening the first session of the new month with the DAX in particular flying, up over 1.8% with other bourses firmly in the black.  In the US, the markets continued to set new records boosted by the very strong private sector ADP jobs report which saw 235k jobs added, far in excess of the 200k expected in October. It should be a guide for what to expect in Friday’s non-farms report. We had the manufacturing ISM activity indicator at 58.7 for October which was below both the expected number and September’s reading. Expansion in US manufacturing activity slowed a little – but it was still a solid enough of a reading.

Rate markets backed-up a little, with the 10-year Bund yielding 0.37% (+1bp), although US Treasuries reversed course (saw 2.40%) after the ISM report to yield 2.36% (-2bp) before closing unchanged at 2.37% and Gilt yields were at 1.35% (+2bp). For the latter, September’s PMI for UK manufacturing was revised higher to 56.3 versus expectations of 55.8 giving the markets more ammunition to think that a rate hike is coming in Thursday BoE meeting. It will be more about trying to contain inflation though, and we wouldn’t see much more potential of a hike for at least through the first half of 2018, if not beyond.

The higher the yield…

From a numbers game, those long enough in the market will look at some of the yields now being offered in the high yield market and think back to only 2013/2014 when these were the yields offered on investment grade debt (cash index). The market distortion arising from the massive manipulation of it by the ECB (and others) has been incredible to observe. In fact, while most would agree that rate markets will likely be less accommodating over the next few years as policy attempts to revert to normal, we’re still seeing money pour into higher yielding debt.

The iBoxx high yield index currently yields just 2.38% having dropped 30bp in October and 174bp this year so far. The investment grade index was yielding 2.40% in Q1 2014 (now just 0.9%) and only fell below 3% in 2013. The CoCo index currently yields 3.17% and the spread on it is B+351bp. The index for both measures has almost halved this year! That is, it started the year at 6.06% and B+664bp for the yields and spread, respectively. And remember, this product is designed to fail in the case a bank finds difficulty in maintaining capital ratios and so on, in extremis, like we have seen for a couple of non-Sifi institutions this year. Those events haven’t spread any contagion into the AT1 market because – rightly for once, they have been viewed as the discrete events they eventually turned out to be. The market kept its nerve.

We would think that central bank heavy handedness (needed admittedly) in the markets has taken away the concept of relative value investing. ‘Yield’ is the name of the game – and it has been for several years. And as long as the default rate stays as close to zero as it is now, then the trade goes on. Even rating transmission risks are limited at the moment. Add into that the secondary markets are more illiquid now than ever, that anyone who sells risks will be penalised heavily should they want or need to rebuild that position. The clear message is to buy, hold, clip the coupon, collect redemption proceeds… and start again.

All our forecasts have been busted for this year, with much of the squeeze coming in the last few weeks. We dare think where valuations in the credit markets will close in this record breaking year. The yield on the HY index through 2% and spreads close on B+200bp (which would be over 200bp lower on both this year)? The CoCo market squeezes further and the yield close on 2.5% with spreads at B+300bp (which would be around -350bp this year for both)? It’s totally possible.

And finally the Fed… or credit

The FOMC played it with a straight bat and delivered just what the market expected. Nothing. And the markets reacted just as we might have expected. It was little changed on the news. Now we move on to the December 12/13 meeting with the full expectation that we’re going to get a 25bp hike in rates. Thereafter, it will depend on who the new Fed chair might be, after Yellen completes her final term in February.

In the credit market, protection costs continued to decline into the positive tone currently benefiting risk asset. iTraxx Main was a touch lower at 49.7bp (-0.3bp) and X-Over dropped to 223.7bp (-1.5bp). There was no primary market activity save for a sterling deal from retirement homes provider Housing & Care 21 for £250m.

We had the continued squeeze in cash. The Markit iBoxx IG cash index tightened to B+95.9bp (-1.9bp) leaving us less than two basis points away from a new low for this index. That record looks like being this week’s business! As indicated above, the CoCo market had spreads tightening again, leaving the index at B+351bp (-10bp) and the yield dropped to 3.17% – both fresh record levels. Similarly, the HY Markit iBoxx index was marked at B+257.8bp (-1.5bp) which was a new record level.

Have a good day.

For the latest on corporate bonds from financial news sources, click here.

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.