11th November 2018

Choppy ride into year-end

MARKET CLOSE:
iTraxx Main

69.7bp, +1.7bp

iTraxx X-Over

286.9bp, +4.5bp

🇩🇪 10 Yr Bund

0.41%, -5bp

iBoxx Corp IG

B+142bp, +1.5bp

iBoxx Corp HY

B+424bp, +7bp

🇺🇸 10 Yr US T-Bond

3.18%, -5bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”24″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”25″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”26″]

Credit still holds some lure…

China, that ol’ chestnut. More signs of a slowdown as evidenced at the end of last week by European luxury goods makers reported earnings was enough to derail immediate hopes that a post-midterm election boost was going to be sustained.

The bullish assessment on the US economy after the latest FOMC meaning that rate hikes for December and (at least 3?) in 2019 coupled with those trade tariffs are putting the squeeze on the domestic Chinese economy. Weakness in Chinese markets thus filtered through to Europe with stocks in the red into the close, but more angst awaits us at the open as the US closed up to 1.6% lower (Nasdaq). Equities are likely going to underperform this year and fixed income, though slightly in the red in total returns terms, is going to be the best of the bunch. Credit especially so.

We clung on to hopes that the good response in the market following the US midterm election result, viewed as reining in of the current administration’s ambitions, would carry us through to year end. It isn’t going to. The Fed’s ambitions matter more and their view of a robust economy is basically a sign that hawkish policy is with us for a while. So we have that weakness developing again in the emerging markets and any slowdown there will be seen in Europe, where the Eurozone’s engine – Germany – is already in the midst of a slowing industrial sector.

Equities, as suggested above, are therefore unlikely going to move materially higher and investors will be nursing large (7% or more) losses come year-end. It’s not necessarily all doom for credit investors, though. A slowing economy against the background of corporate treasury coffers long cash which was raised at record low funding levels. With debt maturities extended such that a wall of funding matters little anytime soon, the ability to service their debt obligations will be relatively well-supported through the next downturn.

The default rate, therefore, will stay at low levels. Credit metrics will remain supportive. Rating transmission risks shouldn’t spook us. The weakness in credit spreads/returns which might come from any weakness in equities will still leave credit to relatively outperform. Thus, rotation risks (credit to equity) ought not to be too much of an issue. We feared it for 2019, but global macro (weakness) looks as if it might just save the day.

Within credit, we would probably move to reducing some financials exposure as the ructions coming out of the Brussels/Italy will feed through into weakness amid apprehension on the banking sector (in Italy especially). Non-Italian paper (maybe other periphery debt too if the contagion sets in) would be a reasonable repositioning should investors want an exposure in the asset class (and here we mean AT1 paper), for example.

That’s not to say that event risk-prone companies will get away without some punishment. They won’t. As if to demonstrate this, on Friday we had Thyssenkrupp out with a profit warning which saw an immediate 20-30bp mark wider on its cash bonds and CDS (5-year up at 175bp, +20bp). Telecom Italia, under much pressure from activist investors as well as a more difficult competitive environment impacting both its mobile and fixed-line businesses, abandoned debt reduction plans with €2bn of asset write-downs to come. With its turnaround effort now on the rocks, its cash curve was 20-30bp wider.


Primary actually surprises

Credit primary can get deals away even if the tea leaves for risk markets aren’t exactly aligned. The good news as we closed out last week was that Grenke Finance revived its deal, pulled earlier this week after some choice comments from a board member, and having sought redemption got €300m in the bag in a short 5-year maturity at midswaps+120bp.

€300m of senior notes for Verisure

In the high yield market, Verisure finally priced its bond/loan transaction. The bond portion saw the borrower issue €300m of senior notes in a 4.5NC1.5 structure priced at 3.5% and tapped the 5.75% 2023s for a further €100m.

This was followed by International Design Group’s dual-tranche deal, for a combined €720m. It was split between a 7NC3 fixed effort for €400m at 6.5% and a 7NC1 €320m deal priced at Euribor+600bp.

The high yield deals took the deal total for the sector for this year to a shade under €62bn, leaving us looking at around €67bn – €70bn as a total for the full year (versus €75bn record in 2017).


A bit of this and that

Tech and energy took the pain on Friday and we closed with the Nasdaq 1.65% lower with the S&P giving up 0.9%. The ‘euphoria’ on Wednesday following the US mid-term election result is all but forgotten, trumped by the FOMC which followed and US rates – or rather the number of them in 2019 – is firmly the focus.

In rates, Gilt yields dropped to 1.48% (-7bp), we think on Brexit fears even if the 3Q UK GDP numbers were solid. There was another ministerial resignation and the May government looks like it is in trouble on this issue. Nevertheless, there was general flight to quality trade and that helped push the 10-year Bund yield to 0.41% (-5bp) and the Treasury to 3.18% (-5bp). Ten-year BTPs were yielding 3.41% (+2bp).

In credit, iTraxx Main gave up 1.7bp to 69.7bp and X-Over closed the week at 286.9bp (+4.5bp), reflecting the weaker sentiment and equity backdrop. And it should come as no surprise that cash was also a little weaker (not helped by the two events mentioned earlier) and the iBoxx IG index closed up at B+142bp (+1.5bp), which is still a couple of basis points tighter in the week. The rally in the underlying pulled total returns closer towards the black (-0.7% YTD).

The focus in HY was the deal flow, but the correlation of the asset class with equities saw to it that the market was defensive and left spreads wider, the index at B+424bp (+7bp).

We would think that there will be some weakness as we open for business this week, as European stocks play catch up and so anticipate a quieter session of it all on Monday activity wise. Primary credit could conceivably deliver some deals nonetheless, as we believe the window is open.

Elsewhere, Brexit talks close in on the end game with a deal expected to be announced between the UK and EU (which will need still to be ratified). We have the Italian/Brussels standoff coming to a head with Italy asked to resubmit its (altered) budget by then. There’s inflation data due from the US and the last of the earnings reports for the season trickle in through the week.

Have a good day.


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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.