- by Suki Mann
It’s very early days with a mixed start to the second half, but the key takeaway is that markets can continue to move higher. Economies are generally back in business. In some cases, further policy stimulus is coming, consumer confidence and industrial sentiment are recovering, while manufacturing and service sector activity hauls itself off the floor. It’s been a deep recession but also a ‘V’ recovery to start with.
The risks are clear, though. We have an earnings season coming up which isn’t going to be a good one, virus second waves are in evidence across several jurisdictions, and the US promises a more disjointed recovery as a result. China is being a nuisance in several key areas although it has pulled back (for now) in its confrontation on the disputed border with India.
In credit specifically, however, we are in the midst of a record run-rate in IG issuance, where Q2 saw €50bn or more issued in each of the months – the first time in Eurobond history. Few treasury desks are taking chances of something more sinister later in the year.
At €268bn of IG non-financial issuance year to date, we should be past the record €318bn from last year by the end of September – en route, quite possibly, to €400bn for the full-year.
The high yield market has finally plugged into the narrative. In a 6-week period from late February and taking in the whole of March, we didn’t get a single deal. But the primary machinery has started to churn them out now, with €13bn issued in June and July off to a decent start (€3.4bn).
And the pipeline builds. Last year’s full-year record total of €76.4bn looks like being surpassed IF risk markets don’t fall out of bed between now and year-end.
So the appetite for HY paper is recovering as the overall news flow improves. Low rates ‘forever’ and the ECB’s recent increased QE-related purchases have turned the screw. There’s a subliminal message in there somewhere. The crowding-out effect (in IG) will reinvigorate that bid for higher-yielding corporate debt.
High Yield Primary Issuance
Spread markets generally stabilised through June following that good recovery through the early part of the quarter. We need equities to push on before we can resume a clear tightening trend. High issuance levels have also contributed to halting the tightening march. It appears the market has taken Wirecard debacle in its stride, while ams AG got its deal away but took out the repricing punishment meted out following the whiff of a potential scandal.
Anyway, the initial widening in HY spreads took us from an iBoxx index level 2020 tight of B+325bp in the middle of February to B+912bp at the peak of the weakness, on 23 March. The record wides came during the financial crisis when the index peaked at B+2200bp (although it was only a €50bn market then versus €350bn now). Spreads have since recovered around 65% of their coronavirus-related widening, with the HY iBoxx index now at B+515bp.
High Yield Bond Index
And we have had high/low beta compression by the bucketload. The Markit iBoxx index spread between the HY and IG indices gapped from a little over 200bp at the beginning of the year to almost 650bp at the worst of the market’s reaction to the pandemic. Since the policy action started and confidence has returned, we have seen a crunch tighter in high yield spreads versus IG and that difference is now at around 365bp.
HY/IG Spread Compression
Spreads seem to have hit a speed bump at the moment, but the background noise remains supportive, and a sub-300bp level on that compression is still quite possible sometime in Q3/4.
Since we started our CreditMarketDaily.com Sterling HY Portfolio, around the middle of April, our holdings have recorded total returns in the two-month period of 10.44%. Against the iBoxx index, which has returned 5.8% (for € market and 8.2% in £ HY), it is outperforming.
The markets are poised to continue to look past the bad news items which will come their way through the summer months. Much of the data is backward-looking and the current crop of reports suggests that recovery in 2020 will see GDP falls of around 10% across European countries but gins in excess of 5% – 6% in 2021.
Still, as as we look at the expected dynamics of the recovery albeit amid the elevated levels of uncertainty that it includes, there is still much to play for. We should not underestimate the impact on markets from cheap and plentiful liquidity. By and large, it’s worked a treat since the financial crisis. And we think it will again.