5th September 2017

Calm before the storm?

iTraxx Main

54.5bp, -0.2bp

iTraxx X-Over

237.2bp, -0.1bp

10 Yr Bund

0.34%, -3bp

iBoxx Corp IG

B+110bp, -0.5bp

iBoxx Corp HY

B+300.8bp, unchanged

10 Yr US T-Bond

2.08%, -8bp

FTSE 100 (live) [stock_ticker symbols=”INDEXFTSE:UKX”  static=”1″ nolink=”1″] DAX (live) [stock_ticker symbols=”INDEXDB:DAX”  static=”1″ nolink=”1″] S&P 500 (live) [stock_ticker symbols=”INDEXSP:.INX”  static=”1″ nolink=”1″]

The risks lurk…

The pricing dynamic amongst most risk-asset groupings suggests that over the past couple of years investors have become battle-hardened to the potential risks. We have barely had a period where weeks have passed and equities, or corporate bond spreads or even commodities have dropped in price in sustained fashion.

As we highlighted in yesterday’s comment, one of the reasons for this (perhaps the main one) is that the huge amount of liquidity in the system have forced it to be the case, as we become more forgiving on the need to get invested.

Perhaps as a result of that, we have just become more pragmatic and asked more enquiringly, why should prices drop? Looking back, we’ve swatted aside the pitfalls faced – asking questions first before firing, so to speak. However, the potential risks are clumping up again and we probably ought not be so complacent about them.

President Trump looks like he is going to be a constant thorn in the side of the markets. However, the latest around the North Korean peninsula suggests that we might be gearing up for something more sinister than we have seen for many a year. It’s difficult to quantify how a ‘battle’ might manifest itself within the global financial system, but we would say this would be an event worthy of a potentially severe and devastating repricing in risk assets.

The debt ceiling debate – taking in the funding of the Mexican border and Trump’s threats to close down the government has had an impact on the extreme front-end of the US Treasury curve, but the rest of the government bond market (everywhere) has failed to act.

Away from the US, we have the usual slower-burning issues around the levels of (growing) Chinese indebtedness – and we are currently giving the authorities the benefit of the doubt that this relatively opaque system of governance will manage to deflate the bubble in orderly fashion (ultimately it won’t); while the debt build up everywhere else is being sustained by the global low rate regime.

History tells us that it will give at some stage, but we’ve had ten years of it and there are likely a few more to go. We’re already putting back the prospect for a rate hike in the US to later in Q4 while the ECB isn’t moving until… 2019, at least. Then we have Brexit, ongoing Middle East geopolitics, the German elections and the Italian ones to come.

That’s a lot to take in, but we reckon the US/Korea issue is the most urgent and quantifiable one which we face. One can only hope that the situation doesn’t get any further out of control. The result might well be anything between a global systemic financial crisis as China directly gets sucked in and trade wars or worse ensue – to a short-lived sell-off where the situation is dealt with forthwith. The market is essentially priced for the latter as a worst case. Alas, you pays your money and you takes your choice.

Primary markets open for business

Credit market participants were keeping calm… and carrying on. We may have derived some comfort from rising equities but, such is the pipeline of deals we couldn’t hold back any longer. For non-financials, Valeo was first up with an increased 5-year, €600m offering priced at midswaps+25bp, or 10bp inside the initial guidance. Daimler came with a quick-fire and increased €500m unremarkable 4-year deal at midswaps+22bp.

Triple tranche: GSK’s €2.4bn in deals

Spanish Telecom giant made what seemed a rare foray of late – for them – in the form of a long 10-year for €1.25bn at mid swaps+90bp (-15bp versus IPT). And then came the session’s biggie, that of GlaxoSmithKline with a triple-tranche transaction. The 3-year, 9-year and 12-year maturity deals saw the group collect a combined €2.4bn and managing to lop between 8-10bp off the initial price talk.

Total Capital issued in sterling for £250m in 7-year funding at Gilts+70bp and Credit Suisse came with an 8NC7 £750m senior deal. In senior financials, Lloyds Bank with a 10-year at midswaps+80bp (€750m) and Belfius Bank (€750m 5-year non-preferred) were the day’s entrants in euros.

This was a good day to get the month-proper started and the deals were mostly all well-received. The total issuance for IG non-financials came in at €4.75bn alongside €1.5bn of senior financial supply.

There was nothing in the high yield market again, but we believe that deals will flow (be priced) as soon as Wednesday. The news flow around the US/North Korean situation was not so ‘front page’ and allowed us carry on in our usual complacent way.

US markets play catch-up

After the US holiday on Monday, the US markets were somewhat in catch-up mode and that left equities in the red as they reacted to the events in North Korea (as well as domestic US issues) over the weekend. European equities were more mixed in the session – mainly down, admittedly. There was a better bid for government bonds though as the Fed’s Brainard suggested caution in lifting rates amid persistent levels of low inflation, in addition to lower-than-expected US factory and durable goods orders for July.

Combined, the news left the 10-year US Treasury yield at 2.08% (a stunning 8bp lower), the equivalent Gilt to yield 1.01% (-5bp) and Bunds yielding 0.34% (-3bp). That 2.75 – 3.00% Treasury forecast view held by many at the beginning of the year seems as far away as it has ever been, while 1.00% for the 10-year Bund yield is equally unlikely this side of 2017.

We’re going to need a sustained economic recovery between now and year-end for us to get anywhere near those higher yield levels. That isn’t going to happen.

That’s actually all really good for credit markets. Corporate bonds will continue to be seen as a ‘safe’ asset offering up a little more yield than ‘safer’ government bonds. Also, returns would have got a fillip in these early sessions of the month with the asset class’ bid supported by the Goldilocks economic scenario which seems to be playing out.

The weaker backdrop in equities didn’t promote a better bid for credit protection, and synthetic iTraxx indices managed to close the session close to unchanged. Main was left at 54.5bp and X-Over at 237.2bp. Cash investors were focused on the primary markets and a limited secondary market had spreads unchanged to a touch better, leaving the cash Markit iBoxx IG index at B+110bp (-0.5bp).

The high yield market closed completely unchanged at B+300bp.

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.