6th August 2017

CoCo (no longer) the clown

iTraxx Main


iTraxx X-Over


10 Yr Bund


iBoxx Corp IG

B+102.8bp, -0.2bp

iBoxx Corp HY

B+277bp, -3bp

10 Yr US T-Bond


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″]

Performance exemplary…

The corporate bond market has quietly and impressively taken a firm hold to finally play out in classic fashion – there is solid investor demand, clearly a low alternative in safe(ish) ‘yielding’ assets, and only average levels of new bond supply – and thus a consistent tightening in spreads. We’re facing records in valuations in the corporate bond market everywhere we look.

This is leading to levels of performance that very few would have imagined at the beginning of the year. That performance is all the more impressive following that rather brutal rate sell-off at the end of June, but we guess is supported by a global economy still playing out in Goldilocks fashion.

Investment grade markets in Europe have been supported by €102bn of direct ECB support over the past 15 months. However, the impact of that lifting only seems to have come through in the past couple of quarters. IG spreads are now just a handful of basis points away from setting new records, measured by the Markit iBoxx index (record low being B+94bp, currently at B+103bp). And even after that 30bp adjustment higher in 10-year Bund yields, for example, we’ve managed to garner +1.2% of performance on 33bp of index spread tightening in the year so far.

As for the high yield market, again the ECB’s IG corporate purchases effort has likely – finally – forced investors down the curve (on a more consistent basis) and into funding borrowers not normally in their remit. As funds take more sub-investment grade debt into their mandates/portfolios, so this market has squeezed to record historical tights in spreads. Almost 140bp has been gained YTD with the iBoxx index spread now at a record low of B+277bp and the daily squeeze is going to see us deeper into record territory over the coming weeks at least.

As impressive, if not more, has been that stellar performance in the AT1/CoCo market. The spread on this index was up at B+1002bp in that very difficult period – only 16 months ago – of Q1 2016. Basically, the market was effectively offered only. Now the index spread level is down at B+424bp and we have had a couple of ‘trigger events’ for lower rated Club Med banks. These have been brushed aside as investors differentiate between the good, bad and ugly of this asset class.

The CoCo index spread isn’t even at its tightest level (B+401bp in June 2014). The index yield has crunched lower though to record levels, and dropped through 4% for the first time, now at 3.93%. Returns? They’re at a whopping 13% YTD! Admittedly, for a product which is ‘designed to fail’ without triggering a bank default, these returns are super in the current (banking sector recovery) climate.

UK struggles but Barclays goes CoCo

It wasn’t a particularly exciting week just passed, but there was some brouhaha around the Dow at one stage breaking through 22,000 for the first time. Otherwise, equities were a little directionless but that is to be expected given the reduced participation levels and the unwillingness of investors to take a position in these holiday weeks. The earnings season has been good, but the economic data again a little more mixed as we fail to break higher on growth with a consistency which would boost stocks.

With that in mind, government bond markets are doing little too. They’ve been better bid if anything, and the symbolic benchmark 10-year Bund yield has dropped to 0.48% and OATs to 0.75%. The Bank of England kept rates unchanged (0.25%) with the Monetary Policy Committee voting 6-2 to do so. The 10-year Gilt yield dropped a little to 1.17% in the week.

In credit, the spreads squeeze has continued – what else! Primary has been mostly closed although we got a few dollar deals away in high yield and a euro-denominated one, in the form of a 6NC1 structure from Limacorporate for €275m. Barclays issued their second sterling denominated AT1 deal of the year in PNC7 format for the 5.875% yielding £1.25bn offering – the previous one from February being over 200bp tighter, highlighting the attraction to investors of this type of banking debt structure (see above).

US jobs offer some good news

It has been a good opening week of the month for fixed income with a little rally in duration risk, and credit continuing to squeeze. Equities have been a little more choppy, but generally we are playing out to an economy failing to break out of this decade long sticky patch and weakness, and we’re on tenterhooks as to hopes that we can return to normality. So, fixed income continues to work.

The US non-farm payrolls report was a strong one with the economy adding 209k jobs in the month (expectations of 180k) while the unemployment rate dropped to 16 year lows at 4.3% and wage growth rose 0.3% in July versus June. That’s all good, but the next hike in rates – if it comes – ought to be at year end we would think. Inflation is still a little sticky as it continues to undershoot the 2% target set by the Fed – and wage growth could be higher.

IG spreads moved just a basis point better last week, to B+102.8bp (iBoxx index) with the HY market also better at record lows of B+277bp for the index. Main was a touch lower at 51.7bp as was X-Over at 231bp.

We will be back again on Tuesday 15th to include the update of the ECB’s latest purchases.

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.