11th December 2018

Equities rally, but few convinced

iTraxx Main

85.9bp, -2.2bp

iTraxx X-Over

346.5bp, -10.5bp

🇩🇪 10 Yr Bund

0.22%, -2bp

iBoxx Corp IG

B+176.4bp, unch

iBoxx Corp HY

B+529.8bp, +3.4bp

🇺🇸 10 Yr US T-Bond

2.85%, unch

🇬🇧 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″]

Prepare for the worst…

There was an early strong bounce back in Tuesday’s session following the big losses previously, but it’s clear that any real zest emerging from it is looking short-lived. Just too much water has passed under the bridge recently and there still remains a massive amount of uncertainty emanating from several quarters. Furthermore, it’s December, with ‘no’ substantial business likely to get done once we have seen off this week.

Brexit continues to dominate and the odds are that May will come back from Brussels, even at this late desperate hour, with as much as what former PM Cameron did before her: Nothing. We believe that ‘No deal’ odds will have increased dramatically. The current uncertainty, therefore, will dog British and EU politics over the Christmas period and well into 2019. For the market, it should be preparing for the worst.

Here’s one to reflect on. So, President Macron yielded to the Gilet Jaunes protests and pulled back on some of his tax cuts, while spending more to appease the lower paid. And we are already aware from Monday’s session that French GDP for 2019 will miss targets as will the budget deficit GDP ratio. However, we don’t see an EC letter coming their way just yet. It just might, though, because the Yellow Vests are sensing political weakness and are likely going to be back out on the streets again this weekend.

Anyway, all of this must this must gall the Italians and maybe gives them some firepower around rules for the rich and different ones for the relatively less well-off nations. It may also embolden their stance against changing their 2019 budget intentions. That said, the markets have shown their displeasure as we are seeing some divergence between OAT and Bund spreads.

Primary credit drew a blank. In ‘normal’ circumstances, the window should have been wide open, especially for an opportunistic offering. After all, the Dax added over 2% at one stage and the opportunity would usually be there. We think that primary might have closed for the year. Investors have likely pushed back on deals given the repricing impact on secondaries they have had, as well as borrowers probably not feeling the love as new issue premiums rise given the level of wider market apprehension.

Worst year for IG credit since 2008

Having held its nerve with losses of less than -1% for much of this year, total returns for IG credit now come in at -1.7% year to date. Incredibly, the corporate bond market is NOT in crisis, but it feels as if it has been routed. It will be the worst year for performance in total return terms since 2008 (-4%) having recorded positive performance each year since that crisis year – apart from 2015 (-1%). Spreads on the IG cash index are 80bp wider.

The explanation? Market manipulation by the ECB’s QE with some investor unwinding ahead of the ending of corporate QE which had previously led to an artificial tightening in spreads. At the same time, investors are needing to (have needed to) consider a plethora of event risk situations (Brexit, Sino/US relations, Turkey, Italy, Russia, Trump) as well as the potential for a down leg in the economic cycle coming fairly abruptly.

With equities battered (Dax off by over 16% depending on the session, YTD) the high yield market was going to feel the pain. Late cycle worsening in some metrics hasn’t helped and a nervous investor has punished recalcitrants quite hard, showing little mercy. The iBoxx IG index spread has added 240bp to B+526bp in a very painful unwind that has seen the worst performance of the asset class since the crisis year of 2008, as we sit on total returns of -4.1%.  In 2011, as the Greek crisis flared up, HY lost just 3%.

An olive branch might be extended, because as we reset the ticker for 2019, yields are higher so the entry point is better. In IG, primary has repriced the secondary market aggressively, though, and investors will be nervous about chasing secondary in case a borrower pops up with a cheap deal and reprices the sector. VW’s €4.25bn, 4-tranche deal back in November was the catalyst, and investors fear that another large blue chip borrower in January adding a cheap €3bn+ will crush January’s performance – and hammer sentiment. So few will want to step into the gaping hole in secondary left by the ECB after it exits the CSPP – unless of course, we’re in bull market mode. That’s unlikely.

Dead cat bounce, classic

As for Wednesday’s session the equity markets were in fine form for the most part, recovering very well before some fading into there European close, but it did offer an opportunity to plug the leak in spread markets. There was a significant boost from reports that China was prepared to cut auto tariffs, while warnings that the storm clouds were gathering for the next financial crisis were largely ignored. China detaining a Canadian diplomat in what looked like a tit-for-tat move following the arrest by the Canadians of the CFO of Huawei also had little impact on risk markets.

The equity market lurch higher was one of relief, but little else. We had a move like this before – in December’s opening session, only for it to fade in the following days. The Dax closed well off the session highs, at 1.5% higher, the FTSE was up 1.3% while a solid rise in the US left equities in the red later (at the time of writing anyway). PM May’s latest desperate trip around Europe saw sterling push higher on hopes of a favourable response, but once we saw that was not coming, the currency dropped to trade off a $1.2515 level.

The rate markets were much more circumspect throughout. There was no sell-off on stronger equities and we ended better bid. Yields were lower in the 10-year Bund (0.22%, -2bp), Gilts yields likewise edged lower (1.18%, -2bp) as those on US Treasuries were unchanged (2.85%). OATs were slightly better offered, with the yield on the 10-year benchmark around 2bp higher at 0.71%.

With that better equity market situation, the cost of credit protection fell. Having also endured a very torrid period, we at least had some respite here, reversing some of Tuesday’s losses, leaving Main 2.2bp lower at 85.9bp and X-Over 10.5bp lower at 346.5bp.

As for cash, the euro and sterling IG markets closed just about unchanged with the iBoxx IG cash index for the former, for example, left at B+176.4bp and the relief was palpable. There was no relief, though, for beleaguered high beta CoCo bondholders with that market still better offered and the index 8bp higher at B+719.6bp (+42bp this month). Finally, high yield was a tad wider, the index showing us B+529.8bp (+3.4bp) at the close (+33bp this month).

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.