14th June 2018

The end of an era

iTraxx Main

65.5bp, -3.5bp

iTraxx X-Over

291.6bp, -7bp

🇩🇪 10 Yr Bund

0.43%, -5bp

iBoxx Corp IG

B+125.2bp, -1.6bp

iBoxx Corp HY

B+376.6bp, +1bp

🇺🇸 10 Yr US T-Bond

2.94%, -4bp

🇬🇧 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″]

Goldilocks ECB policy…

Well, that was a surprise. They’ve gone and done it. QE is all over at the end of this year and the €30bn monthly asset purchases fall to €15bn per month through the final quarter. However, rates are expected to remain unchanged until after next summer, reflecting a fairly dovish posture. And it was rate policy what won the day. The euro took a tumble. They should continue to reinvest the maturing proceeds (which means around €4bn per month in corporate purchases, if all proceeds reinvested) once QE ends – although Draghi was non-committal.

The door is left open for extending all areas of accommodative policy when looking more closely at the nuances in the language, but the signal regards their ultimate intentions was clear enough. The market was strangely unmoved by it, save for volatility around the euro. The Bund was better bid, equities edged a little higher and a stronger euro versus the dollar turned to weakness on the news. Credit perked up as the pipeline grew some more, the cost to insure credit fell and cash spreads moved tighter.

The central bank might have been seen to give with one hand and take away with the other. While assuaging the hawks, we think they also didn’t want to clobber the market all in one go, so they indicated the holding of rates through the summer of 2019. For them to do so, there must be some apprehension regards the macro outlook given the current weakness, especially with a tariff war in the offing. Still, the end of monetary stimulus is now in sight and if the Eurozone’s economy really is on firmer foundations, then that first rate hike will be with us in Q4 of next year.

The ECB cut the 2018 growth forecast to 2.1% from 2.4% in March but left the 2019 and 2020 outlooks unchanged at 1.9% and 1.7%, respectively. Inflation expectations were raised to 1.7% for this year (was 1.4% in March) while 2019 and 2020 inflation expectations were at 1.7% (1.4% previously) and 1.7% (unchanged), respectively.

Primary market thoughts

As we close out the half way point for the month, and approach the same point for the year, it’s worth having a look at the dynamics of the primary market. They’ve disappointed in IG non-financials, are almost ahead of last year’s full-year record breaking level in high yield while senior financial issuance has come in at around average levels, with a serious slowdown following a fairly decent opening quarter.

IG non-financial issuance year to date comes in at €101bn and we drew another blank in Thursday’s session. And it is just €6bn for the month so far with two weeks of business to go. Bayer’s deal is yet to come and will redress some of the imbalance bringing us closer to a healthier level of overall issuance. That deal will be cheap, as the group will be prepared today up for size, needing to be a price taker as it funds the Monsanto acquisition. Even if we get closer to €120bn come the end of June, that will still be over €40bn of less supply versus the corresponding period last year (or -25%)!

The credit cycle has not returned yet, in the traditional sense. The level of central bank policy manipulation has completely thrown the traditional cyclical economics. We’ve had a default rate as close on zero as can be coming up to the best part of 10-years – globally!

The crisis years and low rate environment was a boon for the markets. Corporates have taken full advantage and have gone a long way in disinter mediating their funding from the banking sector. High yield markets of late have had a good run, but that might have been due to the ECB’s QE push in the IG markets (through the crowding out affect). There no sign though releveraging. There’s some M&A but nothing transformational. Investment generally has increased, but nothing which suggests a massive financing boom is ahead of us to fund it.

So, in a sense, we should not be surprised if the dynamics of the IG market have not delivered what we all expected this year – so far anyway. Corporate balance sheets are bloated. There’s no need to print. No rush either given we’re aware that interest rate policy will remain accommodative through most of 2019. The Fed might be rushing along the path to normalisation in interest rates, but the ECB will take a more elongated trajectory towards policy normalisation, despite the pressure from the Bundesbank – even if QE ends in December.

So we will get to the €200bn mark for the year come the end of 2018 – and maybe even €225bn, but the average of the past few years of around €260bn of gross IG non-financial euro-denominated issuance looks unreachable, as things stand. We’re going to need a major post-summer push.

In high yield, issuance for the year to date is at a little over €37bn and 50% of the record total for the full year 2017. Finally, we have to concede that after several years of €50bn+ of issuance, the high yield market in Europe is now standing on its own two feet. We’ll get more colour on that as 2019 progresses and when we resume normal marco-economic cycle. For now, investors are prepared and need to fund high yield corporates as they continue to look for yielder assets, comforted in the knowledge that a low default rate means they stand a good chance of being repaid.

ECB retains optionality on policy

The ECB meeting was enough to make sure activity in the week’s penultimate session was at low levels even if it was a little more brisk post-ECB. Nevertheless, it turned out to be a positive session though for the most part allowing even BASF to pipe up with a £250m deal. They managed to issue at G+63bp, lopping a huge 12bp of the initial guidance – which is a lot for the tightly controlled sterling market. Mind, sterling corporate issuance has been running at extremely light levels this quarter, and the order book for the deal was up at £1.5bn.

The market reaction was as we might have expected – good for rates and good for growth stocks. The potential ending of the QE programme was largely swept aside. Interest rate policy matters more. The weaker euro on the back of the ECB press conference comments served as an additional boost for European stocks with risk markets also heartened by the interest rate stance. The Dax moved 1.8% higher with most other bourses also 1% or more higher. The euro was further pressured after US retail sales for May came in at 0.8% higher versus expectations of a 0.4% rise. US stocks were also higher with the Nasdaq setting new intraday record highs in the process and the VIX at a low 12% area.

In rates, rates were better bid, for example the 2-year Bund yield falling to -0.65% (-3bp) the 5-year yield dropping to -0.21% (-6bp) and the 10-year to 0.43% (-5bp). The 10-year Gilt yield declined to 1.33% (-4bp) while the equivalent US Treasury yield fell to 2.95% (-3bp) with the US 2s/10s flattening some more to as low as 38bp! the 10-year BTP yield dropped t0 2.77% (-5bp).

Credit wasn’t to be left out of the risk asset rally. Protection costs fell sharply. The underperforming iTraxx Main retreated tightened by 3.5bp to 65.5bp and X-Over protection fell by 7bp to 291.6bp.

In secondary cash, we squeezed some more such that the iBoxx index closed 125.2bp (-1.6bp) which was the tightest level in three weeks for this market. Most higher beta sectors closed better but the high yield market – for the moment – wasn’t budging, left at B+376.6bp (+1bp) at the close highlighting little activity here.

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.