10th March 2020

💶 Corporate bonds will get cheaper

iTraxx Main

100.8bp, -2bp

iTraxx X-Over

459.6bp, +3bp

🇩🇪 10 Yr Bund

-0.81%, +3bp

iBoxx Corp IG

B+169bp, unch

iBoxx Corp HY

B+562, +94bp

🇺🇸 10 Yr US T-Bond

0.63%, +13bp

🇬🇧 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″]

Weary and wary markets…

Economic recession beckons. Global growth will fall to well under 3% this year, likely close to 2% (2.9% in 2019). There will be huge consequences of that, not least as we reassess the narrative around globalisation. In the meantime, the troops are being mobilised and had the expected bounce in markets.

But it all feels laboured, suspicious and therefore tentative – as if we are fighting a rearguard action and that the next wave is coming. There was little behind the bounce and the gains were faded.

Covid-19 doesn’t understand policy action. The virus will not be controlled or extinguished by looser financial conditions, although they will go some way in assuaging the worst of the markets’ fears pertaining to a financial market meltdown.

Another Fed rate cut is coming – another 50bp before the end of this month is expected. Trump was doing his best, heaping pressure on the Fed. Markets are anticipating the ECB to cut 10-20bp from the refinancing rate on Thursday as well as some sort of expansion of QE as they increase purchases of government and corporate bonds.

So we will be trading a volatile situation, in a playoff between more unfortunate cases/deaths and rate cuts/fiscal splurge to contain the worst of any downside effects.

There will likely be an adjustment lower in the cost of the TLTRO and they will announce the readying of further measures as and when deemed appropriate.

The ECB is currently lifting an average of €5.5bn of IG non-financial corporate debt every month, which could rise to as much as €9bn. That would send a real message to the corporate bond markets. But it would also increase pressure on investors, now keen to avoid adding any more higher-yielding debt. The ECB would be crowding them out of the IG market – and forcing them into the HY market just as it faces greater levels of macro risk as economic growth stalls.

The lumbering EU is finally talking about relaxing the Maastricht debt criteria, allowing the likes of Italy especially to more effectively support its economy and limit the financial impact of the decimation to come.

The BoE will also be cutting and might not (likely will not) wait until the next MPC meeting (March 26). The UK budget announcement on Wednesday will also go some way in extending a helping hand to help alleviate the worst of what’s to come. That is, we’re very likely heading for an Italian-style lockdown and major governmental financial assistance will make up part of a broad response to it.

At the same time, we think that the oil price shock is a net positive, although shale gas and other industries which are financially and operationally leveraged to a higher oil price will come under massive pressure. By all accounts, the Saudis are going to keep the price lower for an extended period.

Tentative bounce fades

We face a concerted global containment of the Covid-19s spread as well as that policy response designed to stem the economic fallout. That ought perhaps to elicit a more measured market response versus what we saw earlier this week and those 7%+ falls in equities.

The corporate sector is reacting, for example, with capacity and other cuts announced in the airline industry. There’s going to be much more to go, but they will have the ability to react quickly to any post-Covid 19 pick-up in demand.

The US equity markets opened trading higher in a range between 2% – 3%. It didn’t last. That was enough for Europe to give up gains of as much as 3% amid a volatile afternoon session – and equities back into negative territory with losses of up to 1.5% across European bourses at the close. The FTSE only lost another 0.3%.

In the US, the S&P volatility index (Vix) was up at over 50% and US markets were in very choppy form throughout the session, and in the black as at the time of writing.

In rates, the reaction also suggested less of a panic but higher rates in the session might also be due to the expected higher levels of supply as the fiscal taps are turned on. The 10-year Gilt yield rose to 0.22% (+6bp) although there was £2.25bn Gilt auction to contend with. That yield touched a record low of 0.08% on Monday.

The Bund yield also rose, to -0.81% (+3bp) having seen a record low -0.91% previously, while the US Treasury in the 10-year saw yields back-up to 0.63% (+13bp) and off the 0.34% intraday record low from the prior session.

Clearly no one is getting carried away, as the bargain basement of goods will get cheaper. Better to wait.

In the credit market, there was no primary action in the corporate sector or anywhere else for that matter, as we might have expected – save for a €2bn EFSF tap. Elsewhere, we managed to claw back just bits of Monday’s spread weakness, with few convinced of anything.

Protection costs saw a moderate drop in iTraxx Main which crawled to 100.8bp (-2bp) at the close, while X-Over edged 3bp wider to 459.6bp.

In cash, the IG iBoxx market closed at B+169bp (unchanged), but to highlight the illiquidity in the market and lack of activity, the AT1 index closed 34bp tighter at B+630bp.

That didn’t follow through to the high yield market where a sense of panic took hold and a massively defensive bid left the index 94 basis points wider at B+562bp!!!

All eyes are now on the UK budget, and the make up of it with respect to the support the Chancellor/government decides is necessary for British businesses and workers, as part of a coordinated response to a peak Covid 19 shutdown of part or all of the country. On Thursday it is the turn of the ECB.

Have a good day.

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.