15th October 2017

Credit enjoying an Indian summer

iTraxx Main

55.4bp, -0.6bp

iTraxx X-Over

242.9bp, -2.6bp

10 Yr Bund

0.40%, -5bp

iBoxx Corp IG

B+104.9bp, unchanged

iBoxx Corp HY

B+274.2bp, +0.5bp

10 Yr US T-Bond

2.28%, -5bp

FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] S&P 500 [wp_live_scraper id=”10″], [wp_live_scraper id=”11″]

ECB corporate bond QE confuses…

Bereft of any meaningful news flow into the final session of last week, the market was paying some attention to reports that the ECB’s tapering would take in a 50% cut to the current €60bn monthly purchases from January and be extended for 9 months. Reason to be cock-a-hoop? Well, it certainly saw some think that credit spreads would necessarily now be underpinned at current levels and be reason enough to push tighter, too. After all, the central bank’s QE effort has seen an average €1.7bn of IG non-financial debt being taken out of the market every week for 71 weeks now. It has obviously made an impact, but one which has not been quantifiable or blown the spread markets out of the water.

After all, spreads – as measured by the Markit iBoxx cash index – have only tightened 45bp since the corporate programme began, into an improving economic metric which ought to have seen spreads tighten anyway given the level of demand and low policy/market rates. And it has not been a one-way steady – or otherwise – tightening trend. There have been periods where spreads have gapped wider.

So, in our view, there’s no reason to be over-excited by the extension of the QE programme. We actually think that low market rates have been the principal driver for the disproportionate tightening in higher yielding corporate bond spreads although we do recognise that the ECB’s participation has seen a crowding-out impact in IG. Nevertheless, long before the ECB’s involvement, the main entry into the markets for investors was that the primary market and secondary liquidity was already at a premium. It is certainly not clear (to us) that the ECB has been holding the corporate bond market together. Some would have us believe that it has. Remember, it was never broken in the first place.

Risk assets rally on macro data

As for last week, we closed on the front foot. For example, after a fairly unremarkable few days, the data on Friday suggested that the US economy is more than ticking over following upbeat retail sales for September and continued earnings beats in the quarterly season (from the banks). All the while, signs of an increase in inflation remain missing, with core CPI in September unchanged at 1.7%.

That news flow backs-up what we have seeing of late in terms of an economy (which globally) is neither blowing too hot or too cold. And that was good for rates (bonds rallied), it was good for stocks (they rallied) and was good for credit (spreads tightened). The dollar was the loser while the US field curve flattened.

We have records in several equity markets being set on a regular basis, rate markets are stuck wanting to go higher but little signs of inflation and periods of geopolitical event risk are keeping them anchored for the moment. The corporate bond market isn’t an exciting place to be as primary issuance yields little rewards in terms of volume (performance of deals is excellent), but investors continue to see good portfolio returns amid record being set in some sectors here too.

The IG index yield dropped to 1.02% at the close last week which was 4bp lower in the session, for example. Another 2bp takes us to the low for 2017. Spreads were unchanged at B+105bp. High yield spreads were also effectively unchanged (B+274bp) but the index yield dropped to a new record low of 2.56% (-3bp in the session). Returns for the year to date are now at 6%! The CoCo index yield dropped through 3.96% (-4bp) – it has been lower while spreads tightened by 2bp to B+430bp, and we are still 30bp off the record lows in spreads for this index. CoCo market returns have finally hit 14% for the year. Stunning.

On the indices, iTraxx Main closed at 55.4bp (-0.6bp) and X-Over at 242.9bp (-2.6bp).

Primary markets quiet

We’re confused as to why the IG non-financial primary market is blowing so cold. And it has done for a while, as if it ran out of steam before the summer. We would have thought that this year would have thrown up at least the average of the past 3 years (€264bn) but we are unlikely going to get there. This month’s opening two weeks of business have delivered €6.7bn verus €26bn in October last year. Some have pointed to front-end loading of deals (in Q1/2), others might point to bloated balance sheets not needing any further levels of liquidity whatever the marginal benefit of lower costs but we would have expected €260bn+ by the time the year is out. After all, that sort of level has been established as a trend these past three years or so.

The opening two weeks of the month have delivered €3.7bn on HY supply and the year so far is the second-best on record at €52bn for euro-denominated HY issuance. Another €5bn sets a new record and we think that is likely. One might argue that this is where the success has been of Draghi’s QE programme and it has oiled the funding transmission mechanism for lower rated entities. Again, it is unquantifiable as to how much of a direct impact the QE programme has had on the levels of issuance. We would say that the jury is out. After all, €49bn+ has been the annual level of issuance since 2011 (€57bn the record).

As for this week, the US earnings season takes a leg higher in terms of the companies reporting (Goldman, Morgan Stanley, GE etc) and will be the focus for most. Fed speakers are also giving their views in various meetings. Chinese 3rd quarter GDP is also due (expected to be 6.8%). Overall, there is little there to prevent risk asset prices from rising further (credit spreads to continue their squeeze tighter).

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.