15th April 2020

🗞️ Credit markets getting ahead of themselves

iTraxx Main

84.9bp, +7.7bp

iTraxx X-Over

490.4bp, +40bp

🇩🇪 10 Yr Bund

-0.47%, -9bp

iBoxx Corp IG

B+207bp, unchanged

iBoxx Corp HY

B+646bp, +2bp

🇺🇸 10 Yr US T-Bond

0.67%, -8bp

🇬🇧 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″]

Caution is thrown to the wind…

Advanced economies are set to shrink by over 6% this year, so says the IMF. The global economy is expected to take in a decline of 3%. The UK economy will plummet by up to 35% in Q2 alone if the lockdown persists, according to the OBR. Other forecasters have suggested a 10%+ drop in Eurozone growth for 2020.

The earnings season has kicked off on Tuesday with JPM’s net income down by 69% for Q1 as Wells Fargo ‘made’ 1c per share. On Wednesday, BofA (-40% YoY) reported as did Goldmans (-46% ) and Citigroup (-46%) and they all missed. Quelle. Amid much confusion, WTI has dropped through $20 per barrel and close to its lowest level so far this side of the millennium, on fears that the collapse in demand will persist amid a massive glut. US shale has had its day, even if US HY has staged a remarkable recovery on the back of Fed assistance.

These are big headlines. Yet, global equities had broadly been rising. Up until Wednesday’s weaker session the S&P, for example, had clawed back 655 points since hitting those lows and was just 384 points from being flat for the year, or 547 points from its record close, also seen this year. Even the Vix had dropped back at around 40%. The S&P was 70 points lower again at the time of writing.

Credit markets have bounced back, too.

That rising tide has been promoting a better bid across the risk asset spectrum. The credit market’s potential problems in the US seemed to be easing amid a huge HY rally, and the translational effects into the European markets have been felt.

Credit primary has opened this week amid a flurry of financial issues, but we are still seeing pre-earnings blackout period IG non-financials deals on the screens as and when. The spread directional dynamic has become a ratcheting tighter as equity/US credit market confidence has fed into the credit markets in Europe.

Rates are holding up surprisingly well, even as the markets are expected to be flooded by an unprecedented level of government debt to help finance the fiscal response to the economic/health crisis. The yield on the 10-year Bund was back at -0.47% (-9bp), the Gilt yield looks anchored at 0.30% and the US Treasury in the 10-year benchmark has been trading off a 0.70% yield handle for much of the past week or so. Some of that was fear – oil weakness, but not helped by the incoming data following a raft of very low inflation prints for March across several European countries.

The point is that if we continue to rally with the same momentum seen prior to Wednesday’s session, then clearly markets are pricing in a V-shaped economic recovery. For now, we think a W-like recovery would see us establish a floor at around these levels with markets taking in periods of disappointment largely on the chin, knowing full-well that we will emerge the other side eventually boosted by the fiscal profligacy.

Higher beta recovers, but possibly a false dawn

The AT1 index has recovered 50% of its spread widening (-700bp), the high yield index has got back almost 30% of its coronavirus related weakness – or some 270bp (both iBoxx index). These are great spread recoveries, but serve to highlight several issues with these markets.

The first is liquidity, or rather the lack of it in secondary markets. There are specific credit issues around each of these markets but the whipsawing in spreads in many cases masks them. The 12-month trailing global default rate is predicted to hit 10% by year-end, spreads ought to be wider to reflect that.

The technical issues come into play as well. Fund lock-in periods are preventing a much worse scenario when we go wider. Again, there is an inability to transact at a reasonable price (if at all), and there is a disproportionate movement in spreads as a result.

Right now, we’re kind of in a no-mans-land. The earnings season is up on and might shed some light on the state of play across many corporate sectors, in high yield especially. In the meantime, adjusting portfolios to a less risky positioning stance – no need to be overly long triple-Cs when single Bs will do, for example – is costly, if at all possible to execute.

No stopping credit primary

The demand, in primary, for new IG non-financial issues remains at the highest levels ever seen. On Wednesday, Swiss group Givaudan issued €1bn split equally between a 7-year at midswaps+125bp and a 12-year at midswaps+165bp. The demand for the deals came in at a combined €16.2bn (!), and final pricing was 60-70bp inside the initial talk. Of course, the pricing for such can infrequent borrower would have had an element of price discovery about it, but that’s a ‘big miss’.

The other borrower in the non-financial space in euros, was American Honda. They lifted €500m in a no-grow 2-year at midswaps+190bp and €750m in a 4.5-year at midswaps+225bp, with final pricing reflecting a tightening of 40-45bp versus IPT.

Elsewhere, we had Society Generale issue €750m in a 6NC5 senior non-preferred structure at midswaps+150bp (-25bp versus IPT), Guinness Partnership issued £400m in a 35-year at G+145bp (-25bp versus IPT) and Greece was back for the second time this year. They issued €2bn in a 7-year maturity at midswaps+220bp on almost €6bn of demand for the issue.

All that happened against the backdrop of a decent down day in stocks. The markets were all a tizzy. It was data driven and the numbers were brutal. Core retail sales fell by 4.5% in the US in March (MoM) and overall they dropped by a record 8.7% in the month. And then we had one of the biggest declines in US industrial production, as it registered a 5.4% month drop in march, far exceeding expectations of a 4% decline. Manufacturing production declined by an equally impressive 6.3% in the same month, versus expectations pitched at a 3.2% decline.

European equity losses accelerated through the day, with bourses lower by up to 4% (Dax the underperformed) and thereby breaking a 5-day rally. US equities were lower by around 1.5%, at the time of writing. The equity weakness was easily enough to check the impressive tightening we had previously seen in credit spreads, but we didn’t see much of a reversal in spreads.

The IG market closed unchanged, the iBoxx index at B+207bp. Stock weakness and poor bank earnings impacted sentiment and the AT1 market was a touch weaker the index at B+815bp (+30bp). the high yield market held up well though, essentially unchanged, the index at B+646bp.

Credit index moved wider, protection costs rising alongside equity weakness. iTraxx Main moved 7.7bp higher to 84.9bp while X-Over protection rose 40bp to 490.4bp.

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.