10th May 2018

Credit markets, the ECB and QE

iTraxx Main

55.1bp, -1.4bp

iTraxx X-Over

268.0bp, -4.9bp

🇩🇪 10 Yr Bund

0.55%, -1bp

iBoxx Corp IG

B+xxxbp, -+xbp

iBoxx Corp HY

B+329.9bp, +1.5bp

🇺🇸 10 Yr US T-Bond

2.97%, -2.5bp

🇬🇧 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=”15″], [wp_live_scraper id=”16″]

ECB market manipulation: Thank you very much…

We don’t believe the ECB will terminate its QE bond purchase programme come September – but think that it may decide to taper it further from the original €60bn and the current €30bn to perhaps €15bn of purchases per month. They’ve lifted in excess of €150bn of IG ‘non-financial’ corporate debt over 100 weeks of activity, to the end of this week. The average monthly purchases of €7-8bn for the first 70 weeks dropped to around €5-6bn for the next 24 weeks and are now at around just €3bn per month.

The central bank will have accumulated circa €170bn of debt securities in the corporate portfolio by September. Assuming a weighted average life of the portfolio of four years implies €42.5bn maturing per year. So the ECB will need to reinvest circa €3.5bn per month anyway if they terminate completely at that point.

In the early days, it might have been seen by some as a welcome potential support factor for the corporate bond market – although the credit market wasn’t broken and didn’t need fixing. It turned to frustration as secondary market liquidity – already at a premium – became even more scarce.

Since the start of the programme in June 2016, the credit market has tightened, at times ratcheted tighter (mainly in anticipation of the QE programme), but has given up gains as well. The belies the idea that the largest of marginal investors, with the deepest pockets of them all, would see a crunch in spreads to historic tight levels and keep them there. That hasn’t happened.

Going into the announcement that corporate bonds would be included in the purchase programme, spreads were trading in a range B+190bp – 160bp as measured by the IG cash iBoxx index. The ECB started lifting bonds with the index at B+144bp (June 2016). There was a steady tightening but jittery macro kept spreads in a range of B+120bp – 140bp (October 2016 – March 2017). Then we had a steady tightening through much of 2017 into improving macro leaving the index to tighten from B+130bp (April 2017) to around B+100bp (December 2017). We then managed to hit a record low for the iBoxx index at B+82bp in January 2018, before widening to B+106bp now.

So we could explain it away as causality (ECB buying) or happenstance (improving macro) given that we haven’t managed to hold firm in spreads when macro or geopolitics have been the chief headline risk. That is, the jury is out on how much the ECB’s direct massive participation in the IG has actually helped the market; If at all. There is an argument (from credit bulls) that we could have got to current levels without the ECB’s interest on improving macro and credit metrics alone.

The reason for the corporate debt acquisitions was to reduce the cost of funding (by squeezing the market), and forcing borrowers down the credit curve – and to fund higher yielding corporates as they sought to disintermediate their funding reliance away from the banking sector. We could perhaps think that worked, given the record supply we saw in HY markets in 2017 and the current fresh record run rate of issuance in that market. But once again, who is to say that we would not have got there anyway?

Event-risk ticking over, markets rallying though

Thursday’s session was (predictably) a non-event given the various Ascension Day public holidays, and we think that Friday will similarly deliver very little. However, there were still developing situations to keep an eye on.

🇮🇹 Near the top of that list is the potential for elections in Italy – or, to avoid it, the formation of a populist government for the country made up of the anti-establishment Five Star Movement and the far-right League.  Such an eventuality is enough to send a shudder through the markets! And it has, with BTPs once again under some pressure as yields on the 10-year benchmark index rose to 1.93% (+5bp) – or over 20bp in the last week alone.

🇬🇧 The UK delivered yet another set of poor data with construction output down by 2.3% in March and manufacturing output falling by 0.1% in the same month, although it beat expectations of a 0.2% decline. The BoE MPC met, and voted to keep them unchanged by a margin of 7-2 (again), while our own view is that the BoE is unlikely going to raise at all this year (the consensus has pushed out to an August hike – the next meeting). They also slashed GDP growth from 1.8% to 1.4% for 2018. Ten-year Gilt yield moved lower to 1.42% (-4bp) and sterling weakened.

Elsewhere, the Bund yield was also lower at 0.55% (-1bp) while the 10-year Treasury yield fell to 2.97% (-2.5bp). There’s not much of an inflation overshoot in the US as core consumer prices rose by just 0.1% in April month on month (versus 0.2% expectations), and the core figure year-on-year was 2.1% in April (versus 2.2% expectations).

And then there is Trump. The President is always lurking and he is getting all the plaudits so far as North Korea is concerned (meeting with Kim Jong-un is confirmed for 12th June), but the US’ withdrawal from the Iran nuclear deal sees us once again having to refocus on the Middle East. And oil. While the geopolitics play out and inevitable conflicts take their course, the oil price has been firming up. Brent is now trading off a $77-handle, per barrel.

US equities were already higher on the soft inflation data, but took a leg higher after the news of that meeting between the US/North Korea in Singapore was confirmed – representing, therefore, a good week for all the major markets so far. The US was adding up to another 1%, the Dax was up 0.6% and the FTSE by 0.5%. With US equities clawing back losses and back in the black year to date, volatility has been declining with the VIX index now looking to move below 13% (was 17% a week ago).

Credit markets muffled

Primary credit was closed (again). However, we have had some deals this week, three issues totalling €1.5bn in IG non-financials taking the monthly total so far to €4.9bn, with around 2.5 weeks of business left. The high yield market has just come up with Wednesday’s B2B Holding issue, but a busier opening week has the deal total up at €3.4bn.

The Ford new issue floaters on Wednesday were interesting. The 2021 floater was all above-board, but why would investors lift the 2023 issue? In theory, Libor disappears in 2021, so investors who bought the 2023 floater won’t know what they’re going to be getting paid. The potential replacements are SOFR – the Secured Overnight Financing Rate in USD and SONIA in GBP, while the ECB has decided it will develop, before 2020, an unsecured overnight rate. Oh, we have much faith in the ECB.

Generally this week, credit has done very little so far. The Markit iBoxx IG index has barely moved for both IG and HY markets, maybe just very slightly better offered if anything. Activity has obviously been light and turnover/volumes poor, as is now usually the case anyway.

As for Thursday, the cash IG index closed unchanged at B+106.9bp and the high yield index at B+329.9bp (+1.5bp).

Finally, the indices closed out with iTraxx Main at 55.1bp (-1.4bp) and X-Over at 268bp (-4.9bp), reflecting the generally improved tone and higher stock markets.

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.