24th November 2015

Buy, hold, clip coupon… A trader’s nightmare

FTSE 100
6,305, -29
11,092, -28
S&P 500
2,087, -3
iTraxx Main
71bp, unch
iTraxx X-Over Index
295bp, unch
10 Yr Bund
iBoxx Corp IG
B+51.5bp, -0.5bp 
iBoxx Corp HY Index
B+474.6bp, -1bp
10 Yr US T-Bond

Those were the days… We are not fast approaching any kind of inflection point for the corporate bond market, yet there does seem to be a constant worry about liquidity in the secondary market. That is, in the simplest of terms, the ability to trade at a reasonable price. So we will address it again. First, the debate is quite topical we think because investors (1) are struggling to get hold of enough bonds – this is just a supply/demand issue – and (2) in extremis, like in the case of the problems around VW and Glencore, they are finding that the exit price is too painful. Why are the banks not taking the pain, as they traditionally have? Such has been the development of the market around its gross manipulation by central banks through monetary policy operations that over the past five years, the dumbing down of the traditional risk-free rate to zero has seen a colossal amount of money find its way to the corporate bond market. We were all comforted by the low default rate (despite low/no growth) and higher returns (coupons, spreads). Second, political meddling resulting in what can only be described as subsequently poor regulatory decisions has put the traditional providers of liquidity (the trading desks) on the back foot. We would say that those looking for a return to the good old days (80s, 90s, even early 2000s) are wasting their time. They’re not coming back. So what’s next?

Keep fingers crossed and be reasonable… We don’t usually need to worry about that ability to trade at a reasonable price in a reasonable size until we have a crisis, be it around a single name (VW, perhaps Glencore and Anglo American) or sector (commodities, US shale groups) or a systemic one. We would say that for idiosyncratic risk, it’s just bad luck if one needs to exit on an event. For a sector, it’s poor homework – just do it. As for a systemic issue, everyone’s in trouble. Tough. Fortunately, given the current global macro situation, the potential for a systemic crisis is remote. The central banks might have kitchen sinked it, but they would try and do more if a global systemic financial crisis reared – or even looked like it was going to rear – its ugly head. Phew, all good. Buy, hold, clip the coupon. But actually it’s not quite all good after all. There has to be a time when poor secondary market liquidity will have an impact, and there will be some severe hits taken – by everybody. The big, secular trade to be afraid of involves ‘rotation’ from corporate bonds to equities. The driver? A return to sustainable growth, inflation, higher rates and that missing credit cycle. But that’s not happening any time soon. Rest assured, the current frustrations of the market – supply, demand, liquidity, low rates, low yields, perceived ‘tight spreads’ and ultimately value – will be with us through the whole of 2016.

Macro, commmodities and the default rate – oops… Macro data was actually quite supportive on Monday, with eurozone PMIs coming in better than expected in October and hovering at near 5-year highs for manufacturing and near 2-year highs for the service sector. Only the French ones disappointed. Commodities fell to multi-year lows, with copper and zinc particularly under pressure, although oil rebounded after reports suggested the Saudis were willing to cooperate in creating a more stable market. The default rate in the US rose to levels not seen for a while as the shale bubble deflated, as over 60% of the defaulting companies globally are US-based (mostly concentrated in the oil and commodity sectors). in Europe the rate remains very, very low by any standards – and is expected to stay that way for the foreseeable future.

New issue focus… Autostrade, Danone, with NEPI (New Europe Property Inv) also in the markets, and Greece’s OTE (!) due at some stage along with SKF (both also doing tenders for existing deals). Danone’s 8.5-year, Eur750m deal was priced at midswaps+67bp with the book around 3.5x oversubscribed. Autostrade’s Eur750m long 10-year was priced at midswaps+92bp on a book a little under Eur2bn, but was still touch better on the break. NEPI paid up for a 5.25-year at midswaps+362.5bp (to be priced at the time of writing), despite being a low IG-rated borrower. And with it, they bought up the Eur20bn issuance level for the month. There was a fairly rare dual tranche deal from MasterCard as well.

Secondary subdued and mixed… As regular readers will be aware by now, the secondary market was fairly subdued and little changed. The Markit iBoxx IG corporate bond index ended at B+151.4bp and the HY index at B+475bp. The iTraxx indices were unchanged at 71bp and 295bp for Main and X-Over, respectively. The Bund sold off, USTs caught a decent bid, metals were down again and oil ended flattish in a volatile session.

And with all that, 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.