14th October 2018

Corporate credit, a safe haven

iTraxx Main

73.7bp, -0.9bp

iTraxx X-Over

292.7bp, -5.3bp

🇩🇪 10 Yr Bund

0.49%, -3bp

iBoxx Corp IG

B+133.4bp, +0.3bp

iBoxx Corp HY

B+402.4bp, -3bp

🇺🇸 10 Yr US T-Bond

3.17%, +3bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”18″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”20″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”22″]

Heads you win…

Well, that was exciting. Just as many were reaching for the towel (to throw it in), US equity markets bounced – but unconvincingly, offering some relief into the weekend. It isn’t all over – not just yet – but the price action of Friday will keep concerns at elevated levels.

Without knowing how the following week(s) might play out, it is tempting to believe that we are experiencing a healthy correction, where US equities had hit difficult to justify record highs, built on an exuberance emerging largely from the massive fiscal expansion ongoing in the US.

The domestic economy is in rude health (probably mid or end cycle) – the global one isn’t. On the back of it, a tightening labour market and tariff wars are going to pressure the level of inflation across the so-called food chain – and the Fed and US rate markets have reacted. Of course, investors have too.

What happens next is going to depend on several factors. The Q3 earnings season will be one of them but it probably won’t offer anything to become a driver for a market collapse, but rather it will likely give us a little reason to be cheerful – maybe offering some support for risk assets. Already JP Morgan, Citigroup and Wells Fargo kicked us off in fine form with expectation-beating earnings, and the season as a whole in the US is likely to be good. That might be washed away, though – lost in the small print, so to say, by continued concerns that led to the carnage last week in stock markets.

That is, higher interest rates are coming – almost whatever happens, and the Fed is in no mood to halt/slow down the pace. As a result, the massive global corporate/consumer debt boom of the past decade is going to get more expensive to service. The crunch usually always starts with Fed policy (which affects dollar debt servicing). But the ECB is also less effusive in the provision of cheap liquidity just as the Eurozone economy starts to stutter – and still the central bank claims to be on course to end its QE purchases come the end of the year. They might be needing to think again.

Investor realisation that policy tightening is ongoing has become a bigger threat to financial market stability than the various trade wars, geopolitical risks around Turkey, the Middle East and Russia, the Italian budget and Brexit all put together. 

Credit trades relatively firmly

Credit markets are not in the spotlight and that is a good thing at the moment. As we have suggested in previous comments, the asset class is illiquid and selling now to try and rebuild any position later will be futile and expensive. That’s the obligatory lesson garnered from many previous episodes of market volatility through this crisis.

So we have stability in spreads, outperformance of the asset class amid reduced levels of volatility where event risk isn’t necessarily infecting the whole credit market. That is, for example, Italian political and economic risk is contained.

Perhaps one victim more broadly has been the primary market although this year it has barely managed to fire on all cylinders. And few borrowers seem concerned from the potential for higher funding costs once the ECB exits its QE programme. That is, there is no obvious rush to get additional relatively cheaper funding away. Even without a crisis, costs will rise as rates rise and spreads probably edge wider, but there will likely be no stepped increases. Hence, no need to panic.

Recordati recorded a €1.3bn high yield dual-tranche deal

In slightly volatile European equity markets on Friday, we managed to get a couple of sterling deals away (Anglian Water £300m, 11-year green issue at G+127bp and Southern Housing £300m, 29-year at G+158bp) while Fimei’s Recordati printed a huge €1.3bn in a dual-tranche extremely juicy high yield deal.

The latter offered a fixed coupon at 6.75% in a 7NC3 structure and paid €+625bp in a 7NC1 floater, the yield beefy enough to cushion investors from volatility in the underlying.

Investment grade credit traded unchanged on Friday and the iBoxx cash index closed just 4bp wider at B+133.4bp in the week. That’s excellent performance. At the halfway stage, total returns this month are just -0.15% and IG is showing total returns of -0.75% for the year to date. Steady and perhaps boring that might look, but better than the 10.8% loss year to date in German equities.

The high yield market was a touch better bid as we closed last week, the index at B+402.4bp (-3bp) and was 21bp wider for the week. Given its closer correlation (in value terms) to equities, that was still a decent performance. Total returns show a loss of 0.4% this month and just -0.5% for the year to date. Not bad!

As for primary, with two weeks of business left and into the earnings season (read blackout periods), we’re struggling for enough deals. In IG non-financials, it’s €4.7bn of issuance which is extremely poor – for any ‘non-holiday’ month. These are slim pickings so it is a small wonder that borrowers are ramming final pricing tighter versus the initial guidance – and probably could afford to even if books are oversubscribed by less than 3x, say.

In high yield, we’re up at €2.1bn but much of that is courtesy of that Recordati offering last week. Again, this is relatively poor and we’re going to need much less equity volatility for any material rebound in primary.

Expecting a nervous start to the week

US stocks closed higher on Friday by over 1%, but that hid a very volatile session which saw them higher by as much as 2% and in slightly in the red before a late rally.

In the rates market, Bunds were better bid and the yield on the 10-year declined to 0.50%, and to 1.62% for the Gilt (5bp). US Treasury yields moved higher to 3.17% (+3bp). Then we had BTPs where the yield notched up to 3.60% (+2.5bp).

Unfortunately, this week will bring no respite – in any market. We have the EU deadline for budget submissions on Monday and the focus almost entirely is going to be on the Italian one. There is likely going to be much pressure on Italian debt and equity markets with the likelihood of significant headline risk during the early part of this week.

The Brexit talks take a significant step with Barnier briefing European leaders on the latest update. There will likely be no sign-off, but we’re going to get a good idea where it all stands both as far as the EU is concerned, but also where the UK government is regarding its own cabinet’s approval of Prime Minister May’s objectives.

We have the Fed minutes from the last FOMC on Wednesday and the US earnings season continues with the likes of J&J, Goldman’s and Schlumberger all due. Chinese GDP is due, with estimates pitched at 6.6% increase in growth for the first nine months of 2018.

On a positive note, Portugal was upgraded to investment grade by Moody’s (to Baa3/stable) at the end of last week, having languished in sub-investment grade territory since 2011.

Have a good day.

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.