26th January 2020

🦠 Just as credit records beckoned

iTraxx Main

44.6bp, -0.1bp

iTraxx X-Over

218.5bp, +0.5bp

🇩🇪 10 Yr Bund

-0.34%, -3bp

iBoxx Corp IG

B+102bp, unchanged

iBoxx Corp HY

B+347bp, +2bp

🇺🇸 10 Yr US T-Bond

1.69%, -5bp

🇬🇧 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″]

It was all nicely lined up, but…

The market reaction as we closed last week’s final session was one of weakness in the US – as each new coronavirus case outside of China elicited a negative reaction. Notwithstanding that reaction, markets will likely still trade on the hope that the virus break-out isn’t the fabled ‘event’ which risks derailing this great multi-year rally.

The next couple of weeks might tell us if we are wrong, or whether the asset price bubble has some more to inflate.

Equities will likely shoulder and exhibit the brunt of the volatility and until very recently have been setting records. The temptation now is that it is time to think of the same for credit markets – and to position for it. In this asset class, investors haven’t thrown caution to the wind, but do still run a limited high-risk strategy in credit. Much is going to depend on the virus emergency.

However, the initial coronavirus impact on credit has been hard to find. Spreads have barely moved and if anything, are still better bid. There are no sellers. Primary markets are still printing away. Demand has remained at elevated levels. Deals are performing. There has been no volatility (even in the synthetic indices).

Why? The technical support coming from the copious levels of early new year inflows (chasing last year’s stellar returns?) – and not enough issuance to satisfy the demand, leaving that cash almost desperate to find a home.

It has left IG spreads just 20bp away from the record lows – AT1 spreads 75bp and high yield just 85bp (all iBoxx index) away, and with the outperforming IG sterling credit market just 12bp away (total returns at +2.8%! YTD).

For the moment in credit, we would think that it is a case of proceeding with caution but perhaps with a bias towards adding risk if (panic) sellers do emerge.

And then there is the earnings season and the hope that a decent stream of results will help propel US stocks higher still and take everything higher in their slipstream. The S&P index has put in a decent shift in 2020 even after accounting for the recent coronavirus-related losses, adding 80 points (was 120 points) so far this month.

There’s little to suggest that the earnings season will not deliver. It’s been a good one so far. So, if US equities are going to be in the ascendancy at any stage, stocks will push on elsewhere as well and credit is going tighter too. Across the board.

We think that high beta risk will outperform and an illiquid cash market will favour the compression trade. Remember, also, the ECB is busy lifting paper, too – €1.4bn in the last week and €1.3bn in the week before.

There’s therefore considerably more juice in the bid-only AT1 market (it’s been 75bp tighter from current levels, iBoxx index), for example – as many of the banking sector’s perceived risks wane. To demonstrate, last week, Erste Group managed to print €500m with the second lower ever coupon of 3.375% after having garnered interest of €5bn for the issue, which saw final pricing a massive 62.5bp inside the opening talk.

High yield corporate risk is going to benefit, too, so we are looking for the market here to squeeze much more given that it is bereft of any decent liquidity even if primary has been more effusive of late. The key, though, for high yield is sentiment – we need reduced levels of equity/credit volatility (just as we have now) – but macro to blow hot/cold (just as it is now) at worst.

We also like corporate hybrids, but the market is illiquid and there are too few issues being printed. Secondary hybrid credit is also looking rich, though.

Spreads, for example, are already at very tight levels (and matching those of March 2018) – and just 32bp away from their record tights (B+178bp, Jan 2018, iBoxx index). The index yield at 1.58% is already easily a record low. There’s room for hybrid deals and it’s cheap ‘equity’ for borrowers – and new deals will be extremely well sought after, but we wouldn’t necessarily chase secondary.

Mixed PMI, market concern on conoraviras

We had a mixed bag of data at the end of last week, as purchasing manager index data across the US, UK and Eurozone were released. In the Eurozone, the composite PMI for January was unchanged at 50.9 (expectations 51.2), as the services PMI dropped to 52.2 (52.8 previously) but there was a pick up in manufacturing activity to 47.8 (46.3).

The numbers highlight a level of fragility in the economy with little signs of a pick-up, but where risks to the downside might rise if the coronavirus spread affects global trade dynamics.

There was a bounce across the board in the UK, though. The manufacturing PMI rose to 49.8 (47.5 previously), services rose to 52.9 (50.0) and the composite PMI rose to 52.4 (49.3). It was all put down to a Brexit bounce as confidence the UK economy recovers.

These numbers now put a rate cut at the end of January in the balance, having previously thought of as being a dead certainty, following poor retail sales and low inflation numbers.

As for the US, the composite, services and manufacturing PMIs came in at 53.1 (52.7 previously), 53.2 (52.8) and 51.7 ((52.4), respectively. A mixed picture from those numbers, but the confirmation of further coronavirus cases in the US saw equities pressured through the session.

We have a decent bid for rates. The macro outlook is mixed as it always was, but there is going to be an impact on global growth from the disease outbreak, the extent to which is currently unknown. The latest global trade numbers were already pointing to global trade being in the longest period of contraction since the financial crisis. And so there might even be a case for further monetary policy easing. Much will depend on how the coronavirus situation plays out.

The yield on the 10-year Treasury dropped to 1.69% (-5bp), the Bund yield was left at -0.34% (-3bp) and the Gilt yield dropped to 0.56% (-4bp).

On the flip side, European equities were coming under pressure into the close and falling from their intraday highs. The FTSE eventually rose by 1% in the session, the Dax by 1.4% but after the European close we saw US markets fall back into the red, off by up to 0.9%. That was driven by the confirmation of the first cases of coronavirus in the US.

In credit, credit protection costs were unmoved, leaving iTraxx Main at 44.6bp and X-Over at 218.5bp. The IG cash market was unchanged with the iBoxx index at B+102bp – but a basis point tighter in the week.

It was the same for the AT1 market which left the index at B+360bp and altogether representing an investor base not transacting when uncertainty hits other markets – and looking to add when all is calm. The high yield index edged 2bp wider to B+347bp.

The deal flow in the session came from Empark which issued €475m in an 8NC3 structure to yield 1.875% and €100m in a 7NC1 at €+200bp. That took the monthly high yield issuance total too €9.5bn and by far the best start to any year for this category of debt. the other issue came from National Grid, taking £300m in a no grow 11-year maturity at G+87bp (-18bp).

Bad news for all: Coronavirus

As for this week, all eyes are on the news wires and how the spread of the coronavirus is evolving. However, the BoE monetary policy committee meets for the first time this year. Odds for a rate cut have dropped to less than 50% after the PMI and employment data last week.

Having previously thought a 25bp cut was nailed on, we now think they will probably hold fire.

In the US, the FOMC is up on Wednesday and will probably be the big event for the economic calendar. There are durable goods orders, Q4 GDP, consumer spending and income data. In the Eurozone, we have unemployment, industrial & services sentiment and inflation data.

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.