22nd January 2019

Muddling through after a purple patch

iTraxx Main

77.7bp, +2bp

iTraxx X-Over

328.5bp, +9.5bp

🇩🇪 10 Yr Bund

0.24%, -2bp

iBoxx Corp IG

B+169.6bp, -0.2bp

iBoxx Corp HY

B+498bp, +3bp

🇺🇸 10 Yr US T-Bond

2.73%, -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″]

Credit recovery could be sustainable, if…

The outlook for credit appears reasonably good at the moment. But we need equities to play their part – that is, hold these levels at worst – and if they can then, we are going to see more performance from the corporate bond market. And the high/low beta compression play might be on again, although that might be too much to ask. It’s been a while. We’ve widened too much in both areas of the credit market and while entry levels look more appealing in IG, higher yielding paper (not always necessarily high yield corporate debt) is benefiting from the bid for yield.

Nevertheless, if macro activity can plod along at these lower/moderately declining growth levels, then the high yield corporate bond market is going to look oversold. Already in these early skirmishes of 2019, investors have piled into the bank AT1 market and generated some great returns.

The jitters around the slowdown in China (Q4 GDP 6.4%, lowest quarterly growth in almost 20-years) appear fairly limited, it is as if we knew the numbers would be weak and any shuffling or jostling in positions had already occurred. The IMF has since piled in with their own downgrade of global growth this year and next to 3.5% and 3.6%, respectively, although it was the second downgrade in 3 months.

What it has managed do is remind us that macro risks prevail and the ECB will be taking a closer look, but they won’t be offering up anything fresh when they meet this week. The markets are plodding along, perhaps a little more nervous than they have been in the past couple of weeks. In credit, we are squeezing some more as corporate primary throws up deals, but not enough it would seem. the activity is elsewhere.

That’s not so bad, because it means we have some much needed positive performance for an asset class which spent all of 2018 in varying degrees of negative territory. In fact, the likelihood that a low rate environment prevails – through the rest of this year at least, amid little potential for macro cliff risk has allowed the early worms clip up to 5% of performance already in their CoCo holdings.

The demand side of the equation has now boosted higher beta secondary risk – and that is where we have seen the highest levels of interest in primary too. So far this week, Generali has continued the trend seen this year in the clamour for higher yielding paper as it elicited a €4bn+ book for its €500m T2 offering, helping leads reduce the final pricing by 75bp (3.875% yield). Fresenius, ArcelorMittal, Engie and the Italian sovereign also saw massive interest previously this year. On Tuesday, it was Spain’s turn (see later).

Good old days in primary long gone

The cost of borrowing for all borrowers has been rising for a while and is well-off the lows they enjoyed while the manipulative hand of the ECB was distorting the market, through its €172bn QE corporate bond purchases in the June 2016 to December 2018 period.

With rates still relatively low, it is the widening in spreads from those record lows (recorded in January 2018) amid investor trepidation that credit has had its brilliant (decade long) run which is resulting in rising funding costs. Hopefully, spreads have found a new level and any increase in funding costs is purely issuer specific, size related and/or dependent on the prevailing market conditions.

Auchan was the only IG non-financial in the market in the session, and had to pay up big time to get the €1bn, 5-year deal away. It paid well-over 200bp versus its last 5-year effort a couple of years ago, while the company did issue a 2-year floater last January at midswaps+5bp. The French group’s operating performance will have been sorely impacted by the protests win France over the past few months, and now its cost of debt rocketing. The triple-B rated borrower managed to solicit orders of over €3.5bn and finally priced at midswaps+250bp, which was 30bp tighter than the initial (even more eye watering) guidance.

The deal took the month’s IG non-financial total issuance so far to €15bn, and we are slowing down after a relatively bustling start. Sinnce the beginning of last week, we have had just €4.5bn of issuance, and this week’s business will come to a premature end after Wednesday, as the ECB meeting will temporarily close the market.

For the Reit sector, Vonovia issued €500m in a long 6-year at midswaps+145bp while in the senior bank market Citigroup issued a 3-year €1bn green bond at midswaps+58bp. There was the usual plethora of covered bond deals. The high yield market has just the Telecom Italia Mobile deal so far this year, a drought in other words.

The deal of the day was elsewhere though and will have taken all the headlines. That came from Spain with the sovereign borrower lifting €10bn in a long 10-year at midswaps+65bp, and a stunning order book in excess of €45bn.

Reminders abound: It’s tough out there

In macro, the German Zew index on the current economic situation declined to 27.6 and as such to the lowest reading in 4-years. It could have been worse, some argue it should have been but was probably propped up by the positive sentiment in the market since the turn of the year. Whatever, the impact was moderate, as evidenced through only slightly lower German equities, such that the goings-on in the Chinese economy and the trade tariffs outlook are going to have a greater bearing.

Early session weakness in the US with stocks lower by over 1.5% as at the time of writing didn’t have much impact on European equities. The Dax was lower anyway, but by just 0.4% and the FTSE by 1% (stronger sterling a contributor), and that after some solid UK jobs data (wage growth and unemployment). There was some more stuff around Brexit, with the EU refusing to budge suggesting a hard border in Ireland was the default position if the UK leaves without a deal.

In rates, the 10-year Gilt yield was unchanged at a yield of 1.33%, the Bund yield in the same maturity declined to 0.24% (-2bp) as US Treasuries rallied a little, the 10-year yield at 2.73% (-5bp).

Protection costs have been falling quite consistently, but reversed a touch in Tuesday’s session, leaving iTraxx Main up at 77.7bp (+2bp) and X-Over 9.5bp higher at 328.9bp.

As for cash, secondary endured a quieter session following a more than a week of consistent tightening, the iBoxx index finally closing at B+169.6bp (-0.2bp). We saw bit more of a reversal in the CoCo market, but that market moves depending on the ebb and flow of the intra-day tone – with little flow and just a Street marking the sector more defensively should we see weakness elsewhere.

The high yield market is usually similarly impacted and following a a week or so of tightening, we had a bit of weakness here too. There was again no issuance with just the one deal this year so far. Parched of issuance or not, the Street plays it cautious when equities are weak. The iBoxx cash index closed at B+498bp (+3bp).

Have a good day.

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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.