17th June 2016

Blame it on the boogie

FTSE 100
5,951, -16
9,556, -51
S&P 500
2,078, +6
iTraxx Main
87bp, +0.5bp
iTraxx X-Over Index
381bp, +10bp
10 Yr Bund
-0.03%, -1bp
iBoxx Corp IG
B+150bp, +2bp 
iBoxx Corp HY Index
B+515bp, +8bp
10 Yr US T-Bond
1.58%, +1bp

We’re NOT blaming it on the Brexit…

The Fed finally came round to the view of the majority and can no longer talk up the US economy. This is not about Brexit. The referendum is a distraction, in our view, because the global economy has been busted for a very long time. That’s why rates have been zero or negative and unconventional central bank policy has had to be deployed for years now. Brexit only came along a few months ago. Political inaction on structural-level reforms will always be the key and is more important now as the heavy lifting from low rates and QE and the like has been exhausted. We don’t think they will be implemented. That’s why we are likely in the throes of a slow, multi-year readjustment process before we even get close to more normal growth and inflation rates, let alone less accommodative policy. Eight years of post-crisis economic decline and/or weakness doesn’t just threaten to become, but most likely will become,16 years of it. Brexit, Spanish and US elections, other likely referenda and geopolitics will either be distractions or push macro further to the downside.

So we can look forward to more government bond yield curve flattening, deeper negative policy rates, negative yields engulfing more fixed income assets, very volatile (likely lower too) equities and sustained bubbles in real estate and corporate bond markets. We’re going to be flooded with even more liquidity, Japanese style. The whole Swiss government benchmark bond market went negative (yield) at one stage in Thursday’s session, for example. The net result is that we are all going to be adding greater levels of risk as we search for ever riskier, higher yielding assets. The corporate bond market (corporate borrowers, short-term performance) is a beneficiary in this case.

It doesn’t quite feel like February, yet

But it should. Maybe that’s because headline oil prices haven’t collapsed. Or we don’t really have an asset class which is defined by moves of say 4-5 percentage points a day for a prolonged period of time. But European stocks are mostly closer to the February lows than the year’s opening levels, while bond yields on safe-havens are well through levels seen back then – and/or at record lows. The 10-year Treasury yield is at a 3-year low. And a sense of panic seems to be developing. The corporate bond market is holding relatively firm in IG – we think only because the ECB is supporting it – but weakness is apparent in HY, and obviously the iTraxx indices are seeing much activity as investors hedge existing positions or take new ones (long or short). The cost of protecting risk positions has rocketed. Brexit or not, we are likely heading for a summer of discontent for most asset classes.

Off the session lows into the close

Equities closed at their lows for the session, government bond yields did too (this is no bad thing), credit did very little with just one IG borrower in primary, while oil prices also moved lower – again. Other news took in sterling weakness on a Bank of England warning of post-Brexit blues, yet another survey showed Leave in the lead, a Eurostat survey for May had the Eurozone stuck in deflation (-0.1%) and European bank stocks felt some heat as low yields stoked earnings worries (like, all of a sudden). It was a very difficult afternoon session.

We are hoping for a quieter session today, but there are no guarantees that we close out a difficult week more calmly. For now, Gilts yields are close to record low levels with the 10-year at 1.11% (intraday session record low of 1.07%). The equivalent Bund sits close to its intra-day low at -0.03% (-0.038%). The whole of the Swiss benchmark curve is nigh on in negative yield territory and the UST is at 1.58%, having been as low as 1.52% during yesterday’s session! Brent lost almost 2% to trade off a $47 per barrel handle.

In credit, primary delivered just Eutelsat for €500m in IG non-financials. Amazingly, HY primary had another good session with two deals from Cott Finance and Salini Impregilo for a combined €750m. The supply from HY companies has been very impressive – since the ECB started buying IG corporate bonds, while the volume of new deals from IG entities has been very disappointing. We believe deals would have been well-received despite the volatility in equities, but it seems borrowers are in no rush.

Elsewhere, secondary cash spreads continued to leak wider. The Markit iBoxx index for IG corporates was up at B+150bp (+2bp) and that is the widest spread level since the beginning of April although the rally in the underlying left the index yield unchanged at 1.21%. Higher beta IG risk is having the worst of it with CoCos (and corporate hybrids to a lesser extent) seeing particular weakness and spreads in the index 50bp wider already this week. In HY, the index closed at B+515bp and has now widened 26bp this week.

For the indices, Main just edged wider to 87bp, but X-Over saw more weakness, up at 381bp (+10bp). The US saw equities claw back all its losses and more to close out in the black for equities meaning we ought to have calmer end to this week.

With you again on Monday.

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.