3rd December 2017

The grim reaper

iTraxx Main

48.3bp, +0.3bp

iTraxx X-Over

231.1bp, +0.3bp

10 Yr Bund

0.30%, -7bp

iBoxx Corp IG

B+98.9bp, +0.7bp

iBoxx Corp HY

B+292bp, +11bp

10 Yr US T-Bond

2.36%, -5bp

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″]

Is back in his cage…

The weekend’s news of the US Senate passing the tax reform bill, meaning we now go through the detailed process of reconciliation between what the Senate passed and the House of Representatives’ version – before it goes into law – should provide the year-end fillip the markets had been hoping for. So just when we might have been fearful of a difficult December, we ought to be holding on to the year’s gains – and likely adding to them, as markets are boosted by that tax reform news. In the final session last week though, there was trouble at t’mill on the US political scene and much uncertainty on the US Tax reform front resulting in markets took an abrupt turn lower, all following such a positive session to close out November before it. There was a massive bid for safe-haven risk which saw yields plummet.

We saw 10-year US Treasury yields drop by 6bp to 2.35%, Gilt yields in the 10-year fell to 1.23% (-10bp) and Bunds were down 7bp at 0.30%. The US equity indices were all lower, but managed to close off the worst levels of the session. In the first instance, it looks like credit reacted with much more poise as the iTraxx indices only edged 0.3bp higher (noise in real terms) with Main at 48.3bp and X-Over at 231.1bp – because it ought to have been worse. We suspect the weekend’s news flow might now have a positive impact, as we get the broad-based rally to kick us off this week.

Bitcoin: Up 1200% in 12 months

Political event risk is front and centre and into traditionally quieter markets, the lack of liquidity might have a major bearing on asset pricing. Certainly, Michael Flynn is going to be a thorn in the side of the markets (not just the US President) through this month and in 2018. Whether this is brushed aside like so many potentially market derailing events of the past couple of years is something of a wait-and-see situation. After all, the ramifications of the unfolding events could go right to the top of the chain and therefore potentially very difficult and destabilising repercussions for the US President. The tax reform bill will act as a counterbalance and might even dwarf it. Bitcoin recovered and had a super session, and is currently at around £[wp_live_scraper id=”14″].

While we monitor that situation, it would seem that the moves in US markets last Friday were more a result of what might happen on the tax-reform front and news that some headway was still being made helped stocks trim losses. The passing of the bill should be good for all risk assets. We would think that any material down leg in the markets is unlikely now and believe that for credit, activity will wane markedly but we should grind better.

Any weakness in spreads would not be driven by selling pressure. Witness the move in high yield index on Friday which was 11bp wider (month-end index changes notwithstanding) – this was really driven by a defensive Street. Focus will be elsewhere – that is, we think primary markets remain fully open and ready for a lot business – if need be – for the next two weeks.

Fixed income hanging on, US equities zooming

It was a difficult month in November in some respects for the corporate bond market. We saw considerable market weakness in the opening few sessions of the month, and then spent the rest of it trying to claw back the losses. Equities had a better time of it in the US, but strong European currencies managed to make sure that any exuberance in Europe was limited. Rate markets held relatively firm save for the odd bout of weakness, even as the macro data and rate cycle suggest yields ought to be heading significantly higher.

Investment grade credit returns eventually managed to fall only slightly, but sit at a still sprightly +2.5% in the year to the end November. Spreads managed to recover and the month flat. Sterling IG spreads (Markit iBoxx) were wider by 5bp in November, but returns only edged lower as rate markets were kinder, leaving total returns to fall to +3.4% in the period to end November, versus +3.5% in the ten months to October.

The high beta markets were the ones under most pressure earlier in the month as they had previously set record tights. They rallied later but we failed to recover all the losses. The total return performance for HY (Market iBoxx index) was flat +6.3% for this shorter duration market as the underlying was supportive. However, judging by the current economic outlook we are looking at 6.5%+ for the full year as being likely. Spreads though are unlikely to see the record lows as recorded in the opening session of November.

The AT1/CoCo market has also has a superb year so far, the iBoxx index for this structured product recording a +17% performance in the eleven months. Depending on positioning, many investors will have gained more than 20% already.

European equities had a difficult time of it back in August, but recovered hard in September and had a fabulous October. November saw some lost performance as currency woes mainly weighed on the attractiveness of equities. The DAX is up 13.4% this year to end November while the FTSE is only up 2.6% – both registering a decline versus the period to end October. US stocks are consistently posting intraday and/or closing highs and the Dow was up over a stunning 23% to the end of November with the S&P up 18% in the same period.

Spread markets showing some nervousness

Spreads markets had a more difficult November than we might have expected. We went into the month with such high hopes as we hit record tights in most sectors, but there was obviously little behind it (record equities the driver) and much apprehension amongst investors as to whether the levels were justified.

We have had a decent tightening in IG spreads in 2017 (-36bp), and that includes after that modest back up in early November which rattled higher beta assets more than IG markets. Investment grade markets in Europe have been supported around €130bn of direct ECB support over the past 17 months. Still, the back-up in spreads in early November was largely corrected and IG spreads are now 4.7bp away from setting new record tights, measured by the Markit iBoxx index (target B+94bp, currently at B+98.7bp).

Euro HY is in record territory on the supply front, while we backed up from record spread and yield levels after a difficult start to November. Moderate progress has been made since but record spread and index yield levels look unlikely to be tested in December. November was difficult as we gapped 30bp in the month (and +11bp on the opening session of December). Nevertheless, almost 130bp of spread tightening has been achieved YTD with the iBoxx index spread now at B+291bp (01 Dec).

There has been much compression between high and low beta risk. We have been at record tights between the two asset classes (159bp end October), but the sell-off and subsequent recovery only in IG leaves us now at a differential of 192bp. The November decompression was severe. All being said, the continued need for yield amid low policy and market rates, the confidence in the HY market (read demand for new supply) as the global economy looks to pick up a head of steam have all contributing to a broad support for the HY market.

What next?

Without doubt, the US tax reform breakthrough should be what dominates as we open for business. Everything else (almost) pales into significance. It’s the economy stupid, after all, which matters most. Non-Farms are due at the end of the week (188k expectations). In Europe, Brexit negotiations continue with Theresa May meeting with Juncker and Barnier with the UK’s final offer of what it is prepared to stump up.

Primary will dominate in credit, and there is a good chance that it will possibly be busy over the next two weeks. The exciting deal of last week was Friday’s 100-year maturity debut sterling issue from Oxford University which garnered a book of almost £3bn, costing them Gilts+85bp (and well inside the initial price talk). High yield markets have been on fire and November’s activity was excellent as it delivered a little over €9bn making it the best November month since at least 2014. Another €2-3bn is easily possible over the next couple of weeks.

The IG non-financial market is a little more difficult to predict as borrowers here can wait. November saw issuance of €31bn and we have €259bn of issuance in the year to date taking us to the average levels of the previous few years. We’re thinking in the context of €15-20bn of IG non-financial issuance for December, which would make the total level for the year the second best in history. It didn’t look that good several weeks ago.

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.