13th April 2020

🏃‍♂️ Credit spreads tighten: Don’t chase market

iTraxx Main


iTraxx X-Over


🇩🇪 10 Yr Bund


iBoxx Corp IG

B+219bp, -15bp

iBoxx Corp HY

B+680bp, -40bp

🇺🇸 10 Yr US T-Bond

0.75%, +2bp

🇬🇧 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″]

That ol’ chestnut…

Don’t fight the Fed. Who hasn’t heard that one before? It’s come back to bite many a time. And they’re at it again, the market has been rallying. There might be more to come. Few will bet against it, especially if we’re close to passing peak-virus and heading down the other side. Q1/2 earnings/macro numbers are going to be awful, but markets will position for some kind of a V-shaped recovery.

The broad direction across credit spread markets is the same – it usually always is, but the pace of the journey differs depending on the particular sub-sector. All spread markets went down by the elevator (gapped wider) a couple or so weeks ago. We could have expected a grind back (tightening) with the vagaries (liquidity, supply, beta) of each sub-asset class (IG, HY, AT1 and £) determining the particular pace of it.

High yield and AT1 markets have had a super recovery run. Is it reasonable that they do tighten so much? After all, the latest forecasts suggest that, for example, the Eurozone’s GDP could decline by over 10% this year, encompassing a disastrous Q2. Surely that delivers a crushing blow to say the high yield market. Yet one would be forgiven in thinking it’s not that bad judging by the latest market moves.

For example, HY spreads (iBoxx) have tightened by 230bp in two weeks, and the recent wide of B+900bp was 1300bp tighter than the 2008 wides (default rate peak of just 13%). GDP across the Eurozone declined less then as compared to what is expected this time, although that was a financial crisis rather than a health crisis.

The problem now, as then, is that the ECB is creating its own investment grade/high yield divide and waist the markets (investors) to do the heavy lifting for corporates lower down the rating totem pole. In a sense the Fed has acted and will support the best of the HY market, but the ECB is flagging in comparison.

The liquidity injections are unprecedented, but the credit extension is not likely going to funnel down to the SME sector quickly enough. Admittedly, there is a case of the rising tide is lifting all boats after the Fed’s move to help the US markets, but there’s a real chance that we see the tightening stop and reverse materially.

We have reduced levels of visibility, but the lack of secondary market flow (no bid for anything less than BB-, and nothing decent for most of the double-Bs) results in a whipsawing of spreads in both directions depending on the news flow and equities.

High yield primary has delivered a blank as well – it’s been 7 weeks, suggesting a massive lack of appetite, and a prohibitive cost of finance. The IG corporate universe though is printing at record level pace, but we just seem as far away from a HY primary print as ever.

Furthermore, there is little chance that IG investors are going to be crowded out and forced into the HY market, given the ECB’s heavy hand in the ongoing manipulation of the IG market. IG funds will just wait for IG primary, or some clarity on macro and how the next few months are going to play out for HY corporates.

All that said, another rise of 4-5% of equities this week, another glut of IG deals, some more spread tightening – perhaps in the order of 100-200bp in the HY index and we will get a high yield rated corporate print!

Have we missed a trade?

We are going to be thinking in terms of having missed a trade, after the relatively big pullback in spreads. From the pandemic-induced wides of 3 weeks ago, IG spreads (iBoxx index) are 40bp tighter (B+219bp), AT1 spreads are 620bp tighter (B+890bp), the HY market is 230bp better off (B+680bp) and in sterling, the index is 70bp tighter at G+223bp.

We are not going back to the pre-pandemic levels this side of Q3. The big question is whether we can get through the summer without a disaster for non-investment grade companies, although even IG corporates in the triple-B sector are going to feel much heat.

We think that a lot of the froth has been blown away this past week or so. Equities have rallied and given a boost to an illiquid secondary market, pushing spreads tighter on the smallest of flows. The inability to transact at a reasonable level (if at all) will not have been lost on anyone.

Net net, we would probably go with the flow. Add selectively. Add in IG in primary. Pick off any emerging liquidity in fancied paper if possible. Expect some weakness, but hope for the best. Don’t chase the market, though.

Nearing the virus-peak, the market expects

So re-opening after Monday’s Easter Bank Holiday close, we’re all wondering the next move in primary. At this half-way stage of the month, April’s issuance is already up at €35bn for IG non-financial issuance, coming after that huge €45.8bn in March. The year to date is at a record run-rate of €131bn! There’s little reason to think that we should not expect to see more of the same and we could – most likely will – be looking at the first €50bn+ month since 2009.

As mentioned already, we haven’t seen a high yield deal since Catalent Pharma issued €825m back on Feb 20, but we will stick our neck out and suggest that if the spread tightening trajectory continues in the same vein for the next few sessions, then a good, perhaps national champion, high double-B rated borrower will pop-up.

Other than that, the poorer macro data is now beginning to emerge. The debate is well on the way as to whether the stimulus packages will be enough to engender a V-recovery. Or whether early hopes of a rocket higher will unravel on another Covid-19 outbreak and perhaps a series of lockdowns which puts a sudden stop to the recovery potential.

For now,  we’re into the opening of the earnings season which add a little more flavour. It isn’t going to be pretty. The market has reacted to the stimulus packages and will ‘forward look’ as much as possible, but there will be no hiding from possibly the most dire of earnings streams in recent memory. The visibility on the medium-term outlooks will be non-existent with many not bothering to proffer a view.

JPMorgan kicks us off, but all the big banks are due with Wells, BofA, Citi, Goldmans and Morgan Stanley to follow. the numbers will be down. Of course, trading revenues will be higher, but we will see loan loss reserves beefed up, low interest rates will bite and so on. Non-banks have J&J, Abbot Labs and Schlumberger keenly watched amongst others.

The markets were mostly closed on Monday, but we did have Ford announce that it expects losses of $600m in Q1. Moody’s suggested the default rate rising from around 3.5% currently to around 10% at year-end, still lower than the 2009 peak of 13%. And US equities were around 2% lower heading into the afternoon session.

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.