29th March 2020

🦠 The Covid-19 credit gimme trade

iTraxx Main

93.9bp, +8.5bp

iTraxx X-Over

576.2bp, +60.9bp

🇩🇪 10 Yr Bund

-0.47%, -10bp

iBoxx Corp IG

B+255bp, -1bp

iBoxx Corp HY

B+803bp, -26bp

🇺🇸 10 Yr US T-Bond

0.67%, -14bp

🇬🇧 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″]

Event-risk to offer more opportunities…

It looks like the IG corporate bond market is healing, albeit leaving a nasty scar. Corporates are playing the short game, borne from a necessity of shoring up balance sheets – and paying up for it. Of course, some of their justification for a print comes from the still historically low coupon payments, but they’re going to decline again – and stay low for years to come. These corporates could afford to wait.

Investors are playing the longer game. We think that the IG issuance is effectively akin to distressed borrowing given that the entities issuing are rock-solid credits, unlikely going to default or see ratings culled as a result of this recession.

Low policy rates forever means demand for this type of higher-rated instrument (paying more than the ‘risk-free’ rate) is the ‘gimme trade’ of the crisis.

That is, the likely V-shaped recovery is going to see spreads on some of the issues tighten by 100-150bp (some are already well on the way). Investors see that and have been falling over themselves to get their hands on the issues. This is 2009 all over again.

On Friday, after a quite excellent recovery week for the markets, we had some significant weakness into an uncertain weekend. And the virus continued its rampage. It took in Boris Johnson (and his Health Secretary), and sharply lower UK equities on the headline risk.

So we have frequently suggested that there will be more opportunities, with the aforementioned event risk situations giving investors many more bottoms to pick.

Spread trends by rating 2020

This chart shows the trend in spreads for the Investment Grade rating category for AAA, AA, A and BBB rated bonds, for the euro-denominated corporate bond market.

Having maintained a steady trend through 2019 and obviously into 2020 (before the Covid 19 situation escalated), we now have the volatility and weakness that we might expect shown to a much greater extent higher beta credit.

For example, the difference in spread between triple-A and triple-B credit was stable at around 65bp and that was essentially maintained right through to the end of February 2020. We’ve seen a massive gapping in the difference, the spread between the two more than doubling to around 150bp now.

We see that the difference has not moved as much between the more populated single-A and triple-B categories, from 40bp pre-Covid 19 to 60bp now, although both sectors have seen a significant gapping in spread.

The reasons are numerous. We have a firmer support bid for triple-A credit (quality always demand in a crisis). Triple-B credit is a much bigger part of the market and takes into account all the periphery based borrowers. Secondary market illiquidity has not helped either so we see an exaggerated weak bid (if any) for lower-rated credit.

On the flip side, the snap back into any recovery will be more pronounced here. For the opportunistic investor, there lies the trade.

The chart below shows the spread trend in the high yield rating category for BB, B and CCC rated bonds, for the euro-denominated corporate bond market.

There was relative stability between the various ratings groups and even signs of compression into the record equity market rally during the opening weeks of the year.

The difference between double-B/single-B was typically in the 300bp area, while it compressed to around 400bp pre-virus outbreak. Since then, the former has widened to around 500bp while the latter has only risen to 600bp.

Admittedly, the cohort in the latter (triple-Cs) isn’t huge and pricing transparency isn’t great. Double-Bs have widened more on a percentage basis – a function of a deeper market for them.

Nevertheless, the trend is textbook and we would think recovery in these markets overall will be much more laboured – an illiquid driven snap back aside – given the high yield sector’s greater correlation with developments in macro.

Direction as uncertain as ever

Few should be surprised that the wheels of the EU-27 decision-making processes continue to turn very slowly. This time they failed to agree on a collective (thought to be 2% GDP) bailout package, instead kicking it out into the grass for up to a couple of more weeks.

Amongst news of the continued rise in deaths and perhaps some profit-taking ahead of the weekend, the FTSE lost 5.2%, the Dax 3.7% and the US indices up to 4%. Government bonds managed a much better bid, the 10-year benchmark Gilt yield dropped to 0.35% -5bp, the Bund to -0.47% (-10bp) and the 10-year Treasury yield dropped by 14bp to 0.67%.

For credit, the week was a high beta partial spread recovery week, but it was mainly all about IG primary. The levels to get deals away for quality financial and non-financials reflected those last seen in 2009. Investors, as highlighted already, piled in.

Adding in the €750m printed by Mondi PLC on Friday, we had a massive €21.2bn issued in the week with interest so high that the Air Liquide deal had interest of 22x its €1bn dual-tranche offering. That was probably an IG non-financial record.

The point is that there is cash to put to work and investors are looking at the long game, anticipating a massive spread recovery (or not, because one can be happy with the levels) once we get a grip on this pandemic. There was also €10bn issued in senior financials.

Credit was mixed in last week’s final session. For instance, we ran out of steam on index as equities gave a fair bit back in the final session. So iTraxx Main moved 8.5bp higher to 93.9bp and X-Over was almost 60bp higher at 576.2bp. The ratio crept higher to 6.1x.

Cash was firmer though, again. That’s encouraging. In the AT1 market, spreads were a touch better and the index level was at B+1,075bp (-45bp/Friday, -550bp from the record wide of Monday). Losses year to date have improved to -16% (helped by the rally as well in the underlying).

However, after the close we had the ECB order that Eurozone banks suspend dividends and share buybacks (until October), but there was no word on the suspension of AT1 coupon payments. That might come – independent of an ECB instruction to do so. And so the fun and games here might be about to resume.

The IG market was essentially unchanged at B+255bp (-1bp) as all the issuance weighed on secondary, while we had another decent gain in the high yield market with the index left at B+803bp (-26bp). The lack of deals in the sterling corporate market is helping that market squeeze into any improved tone, and the sterling IG corporate index tightened 7bp to G+275bp on Friday.

After the close on Friday, Fitch moved to downgrade the UK to AA- and Moody’s lowered South Africa’s to sub-investment grade. Some how, those moves don’t seem important and we think will largely be ignored. This week, we have confidence and sentiment data, inflation, GDP and unemployment numbers as well as retail sales and manufacturing reports across the various regions. Belt up.

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.