3rd June 2018

If you can’t beat ’em, join ’em

iTraxx Main

67.4bp, -2.8bp

iTraxx X-Over

295.1bp, -14.1bp

🇩🇪 10 Yr Bund

0.39%, +5bp

iBoxx Corp IG

B+129bp, -3.5bp

iBoxx Corp HY

B+384.6bp, -10bp

🇺🇸 10 Yr US T-Bond

2.90%, +8bp

🇬🇧 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=”15″], [wp_live_scraper id=”16″]

False dawn or not, it feels better…

Liquidity. There is too much of it in the world and the cash needs a home. Unless the ‘event risk’ actually materialises, the lesson of the past week is that the pullbacks are buying opportunities. There have been so many occasions over the past couple of years where trouble has loomed, the markets recoiled, but then recovered sharply. And they’ve done – are doing – it again. Only a few days ago the markets were on the way to pricing in financial Armageddon. Not any more!

Italy has a new government, but as yet, we are none-the-wiser as to what/how its policy programme might evolve. Spain has a new PM after the incumbent Rajoy was ousted following a vote of no confidence and replaced by the socialist PSOE party leader Pedro Sanchez, but few are expecting much to be different for the moment there. As for the US import tariff spat, the afflicted parties have thrown their toys out of the pram, but in the words of Wilbur Ross, the US Secretary of Commerce “… the markets will adjust (to any trade sanctions)”.

So, there we have it. It looks like the markets have adjusted already to all the aforementioned event risks, with an attention span measured in days, rather than weeks or months. The expectation must be that the Italians will huff and puff, the recovery in the Italian debt and equity markets will be seen as a sign that the new administration isn’t going to follow through with the worst of the previously touted policies and that Brussels will have won the day again. The Eurozone goes on, in its current format.

As for a global trade war, we might have to see how events evolve, but this is going to be one of those long-term, slow unwinding issues, with some impact on global growth but without knowing exactly how much of an impact any tit-for-tat retaliatory tariffs might have had. Some sort of fraction of a percentage point will be neither here or there. The EU has already fired back, taking some sort of moral high ground but refusing to enter into any further negotiations as bourbon whiskey and Harley-Davidson amongst other items look like becoming a little more expensive in Europe!

Really upsetting the apple cart probably requires some sort of global conflagration. That’s as far away as we might reasonably expect. So, once again, we’ve gone from thinking of June requiring a cautious investing mentality to one which might see a more positive outlook for risk assets. We just keep swatting away all the emerging/potential event risk situations that might lead to a sustainable fall in risk assets.

However, before we get carried away, we would proceed with caution. After all, we are just a headline away – likely emerging from Italy – from another blowout.

So we closed out last week/start of the opening trading session of the month in a very upbeat mood. The declines in the period mid-May onwards were on their way to being almost completely reversed. Equities were on the up and BTPs rallied leaving the 10-year to yield 2.68% (-14bp) and almost 80bp off last weeks intraday recent peak. The markets immediate focus, though, was on the 223k of US non-farm payroll addition (consensus was for 193k), while average hourly earnings rose 2.7% in May year-on-year (2.6% in April) and the unemployment rate at 3.8% hit a near two-decade low. In addition, the ISM manufacturing gauge rose to 58.4, ahead of the 58.1 expectations with construction spending also at a two-year high.

Treasuries succumbed to the news, the 10-year some 8bp higher at 2.90% (three more rate hikes in the US this year?), dragging Bund yields higher to 0.39% (+5bp, 10-year) although some of that was due to the safe-haven bid unwinding on hopes Italian politicians come to their senses (in Brussels/market terms).

Italian political event risk sullies May’s performance

After a better April, and hopes at the beginning of May that the month would bring further market rallies, we ended up under some pressure in the Month. Italian political woes were the chief culprit for the late sell-off in the month, although fears of a global trade war and the Spanish vote of confidence in the ruling party also heightened nerves.

Credit spreads gapped wider, equities were volatile but didn’t quite fall out of bed, Italian debt and equity markets plummeted – only to recover in the final session, and safe-havens caught a bid but not enough to keep us in the black year-to-date.

As it stands in the opening five months of the year, the DAX is now off 2.5% representing a small decline from the weakness in the Jan-Apr period. The FTSE fared better, helped by a weakening of the currency and was flat in the Jan-May period. US equity markets had been more resilient, with S&P up 1.2% and the Dow lower by 1.2%, versus -0.9% and -2.2% in Jan-April, respectively.

Eurozone sovereigns rallied on the back of the increasing event risk and the Markit iBoxx Eurozone sovereign index but ended falling into the red on a total return basis, recording total returns of -0.25% (to end May) versus +1% in the opening four months of the year.

In credit, IG spreads gapped by almost 30bp, and whilst the underlying was rallying returns fell a touch more to -0.6% for the year to end May (versus s-0.4% to end April). The high yield market did worse, spreads gapping by over 70bp on the iBoxx index and returns at -1.2% in the opening five months, versus 0.1% in the Jan-Apr period.

The firmer tone in the Gilt market through May, as the data showed a slowing in the UK economy with the likelihood of no rate hike this year (in our view), helped offset the more moderate corporate spread weakness and returns were a little improved at -1.3% in the opening five-month period.

Headline risks will dictate the trend

The vagaries of the corporate bond market vis-a-vis illiquidity and reduced levels of activity usually mean big moves in valuations through periods of volatility and uncertainty elsewhere. We run scared, the Street refuses to put a bid on anything and it looks like the market has fallen out of bed. When usually it hasn’t.

We can also move the other way, where the Street refuses to offer anything (or much) and we get an almighty squeeze and this time, investors frustrated they can’t get hold of paper. For that to happen though, we’re going to need an almighty rally in equities likely borne from an acquiescent Italian government policy and a hugely successful summit in Singapore next week. It would help also if we get some calm on the trade war front, too.

So, it won’t happen, but if we get less in terms of negative headlines, then we do have a chance of squeezing better. Some of that was seen in June’s opening session on Friday, where the positive tone allowed spreads to tighten, by 3.5bp on the IG iBoxx cash index to B+129bp and by 10bp on the HY index to B+384bp.

We think that the markets are now at the mercy of the aforementioned situations, and the unpredictably that they represent. We, therefore, have found a new level in which to trade off, the direction of which will depend on the risks as they emerge over the next several weeks. Primary has been quiet of late although we’ve had the odd print in HY, and again, the window of opportunity for getting deals away is going to depend on the prevailing mood across the whole market.

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.