4th April 2017

Chapter 4: Caution

FTSE 100
7,283, -40
12,257, -56
S&P 500
2,359, -4
iTraxx Main
75bp, +1.5bp
iTraxx X-Over Index
293.5bp, +3.5bp
10 Yr Bund
0.28%, -5bp
iBoxx Corp IG
B+130bp, +0.5bp 
iBoxx Corp HY Index
B+375bp, +8bp
10 Yr US T-Bond
2.32%, -7bp

Borrow or be damned

The Eurozone’s data flow was off to a flying start with the unemployment rate dropping to 9.5% and at early 2009 levels (was below 7% in 2007) – and Italian manufacturing feeling the pull of recovery elsewhere in the region as PMIs hit their best monthly level since 2011.

The UK, on the other hand, saw it’s manufacturing sector growth disappoint for the second month in row with PMIs dropping and the pace of expansion slowing in the quarter. The net effect was that government bonds got a better bid behind them, equities played out in a small range for much of the session until the US opened and turned lower, while credit did very little as we might expect for the opening session in any week.

Borrowers, though, were not shy in coming forward – with several deals on the screens to get us started for what could be a busy week on the primary front ahead of the Easter break. Then we are into those French elections.

RCI kicked us off in the corporate primary new issue market with a dual tranche €1.35bn and managed to reduce the initial price talk by 12-15bp across the two tranches. That’s after a stellar €37bn in March and some €87bn in the opening quarter of the year. The deal was the only one in the non-financial sector. Senior banks were represented by CBA which visited for €750m in a long 5-year and BBVA for a €1.5bn 5-year maturity non-preferred issue.

The banking sector has been the outperforming one in Q1 (total returns) and there is a particularly good bid for the higher yielding product. This might see more borrowers look to get deals away in the T2/AT1 market over the next few months.

The high yield market drew a blank after having a super €10bn+ month in March. Sterling issuance saw Metlife Global Funding take £400m, with a £100m tap issue from SEK.

ECB lifting an average €1.7bn per week, but for how long?

Pulling back: The ECB

The ECB reports its latest weekly IG corporate bond purchases later today, but the ECB has been lifting an average of €1.7bn or corporate debt per week for over 10 months now (€74bn), and spreads (as measured by the market iBoxx index for IG corporate bonds) have tightened by only 20bp. From around B+152bp to B+129bp. This year they have only tightened by 6bp.

We would argue that given the limited movement in spreads – and this year they have tightened mainly in March due to an improved macro outlook, a few will be fretting as to how the market might look in a few months time. If that much debt (10% of the eligible market) has permanently been removed from the market and spreads have relatively tightened by such a small amount, it can’t look good when the ECB starts to reduce its purchases.

The big QE effort sees the ECB reduce bond purchases from €80bn to €60bn per month. How much of that 25% reduction will impact corporate bonds – we don’t know. There might be an element of proportionality in the take-down, but it is not a given. Still, we know they’re reducing purchases and they will cut their purchases further in 2018.

Overall, it is difficult to assess how much they have affected the market apart from believing that the ECB’s involvement in the corporate bond market has reduced secondary market volatility, while at the same time further reducing liquidity. An improving macro outlook will lead to improved credit metrics and those fundamentals ought to elicit a tightening trend in spreads – perhaps offsetting the lower corporate bond purchases by the central bank.

So, reducing purchases over a period of time and into better macro conditions might appear as if the ECB has perfected a seamless transition for this manipulative ECB bond buying phase to play out and end in. That was always the plan. We’re set up – at best therefore – for a grind tighter in spreads through 2017. “At best” because portfolio managers might just have to contend with material outflows depending on how the growth/inflation/equity and rate market dynamic plays out.

Markets cautious as US auto sales disappoint

The rest was about easing our way into the new quarter amid the potential in some cases of a change in strategy. That’s how we started until the US data came in. US manufacturing (as measured through the ISM index) came in a little lower than expected (but was still good) while US auto sales dropped in March versus a year ago. The latter we suspect was enough for equities to move lower by around 0.5% across the board.

Government bonds were better bid which saw the 10-year Gilt yield lower at 1.06% (-8bp), the equivalent maturity Bund at 0.28% (-5bp) and some latest poll jitters probably ensuring that OATs backed up with the 10-year yield at 0.98% (+2bp) – before it settled flat at 0.96%. It’s been a while since the Bund yield broke lower and out of the 0.30-0.50% range for the 10-year. The 10-year US Treasury yield meanwhile fell to 2.32% (-7bp) and just holding in its recently established 2.30 – 2.60% range. Rate markets overall continue to defy gravity. Yields are supposed to ramping higher!

In the secondary corporate bond market, we had a slight risk off moment and (as measured by the Markit iBoxx corporate bond index) we edged to B+130bp (+0.5bp). The sterling market edged wider too, by 0.5bp with the index left at B+152bp. Index changes over month-end and perhaps a little bit of equity weakness saw to it that the HY index was up at B+375bp (+8bp). And finally, the risk-off tone into the close took its toll on the synthetic indices with Main closing at 75bp (+1.5bp) and X-Over at 293.5bp (+3.5bp).

Have a good day, back tomorrow.

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.