17th May 2020

⚖️ Delicately poised

iTraxx Main

90.2bp, +0.7bp

iTraxx X-Over

540bp, +4bp

🇩🇪 10 Yr Bund

-0.53%, unchanged

iBoxx Corp IG

B+207bp, +1bp

iBoxx Corp HY

B+676bp, +3bp

🇺🇸 10 Yr US T-Bond

0.65%, +3bp

🇬🇧 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 market feeling some heat…

The Q1 data is out of the way. And as bad as that quarter was (ending with Eurozone GDP coming in at -3.8%), it was mostly all as expected. April’s numbers are worse (we had US industrial production and retail sales fall off a cliff on Friday), May’s data will barely be better but helped a little by the easing in the lockdowns, although we should stem much of the downward quarterly trend through June. But it will still be bad.

In the meantime, there is still much that can go wrong, even if the markets are looking at H2 with the glass half full. China’s economy is up and running. Each data point from there seems now to boost sentiment. Equities have settled in a new range significantly higher than their late March low levels. Rates seem to have found a floor, too, where benchmark yields have been in a narrow corridor for several weeks. Credit, though, is beginning to feel the pinch a bit.

The emerging view of a slower macroeconomic recovery dynamic amid secondary wave virus effects doesn’t help. The huge IG supply, neatly absorbed, doesn’t help promote a bid for secondary. There is clearly some indigestion in the market and we are not helped by any equity volatility and/or headline risks. Spreads have been drifting wider.

So the expected poor Q2 in macro is going to filter into the weaker credit names and we might see some more risks around those weak triple-B/double-B and certainly single-B and lower-rated names. Sappi‘s €250m deal, slated for launch on Friday – was pulled, by way of an example.

Nevertheless, the high yield market appears to have avoided the worst of the weakness that hit valuations 2008. Many borrowers have been helped by weaker covenants, funding disintermediation alleviating the need for desperate issuance or otherwise and investors by other technical factors (fund lock-in periods, for example). Can it hold?

The point is, furlough schemes and the like may just have delayed their day of reckoning. Once the schemes and various other stimulus packages are withdrawn – as they will be soon – then we need a V-recovery or close to it. Otherwise, revenue and revenue growth are not going to sustain businesses models or generate the necessary cashflows to keep servicing debts over the short to medium term.

Primary slows as headline risks mount

The €26bn of IG non-financial issuance last week came in the 3-day Monday to Wednesday period, as we drew a blank on Thursday and Friday into equity weakness during those sessions. For the month so far we have seen €37bn issued and, given the huge amounts of deals seen in the past 10 weeks, we would think an attempt on the April record month (€57bn) is going to fail. We look for issuance levels to lighten up from here.

Subscriptions are declining, new issue premiums are becoming less attractive and final pricing versus the initial talk is tightening up less as well. Deals are not all necessarily trading tighter on the break. Confidence is ebbing away, slowly.

And, as if to ram the point home, the recovery in the high yield market of late came to an abrupt halt, as Sappi Papier pulled its deal on Friday, citing adverse market conditions.

This week’s overall deal flow and dynamics will again depend on the mood in the equity markets and we have plenty to think about on that front.

Disjointed risk markets

The US data at the end of last week served to keep equities there in the red, but we think there was more of an impact coming from the US-China trade difficulties and now ongoing relationship in any form, arising from the Covid-19 blame game. Industrial production nevertheless declined by 11.2% in April versus March and retail sales fell by a record 16.2% in April month on month.

A weak sterling helped propel the FTSE 1% higher, the Dax rose by 0.8% and the US equity markets were trading lower for much of the session before a late rally pushed the markets into the black at the close. Rates were flattish in the session leaving the 10-year Bund yield at -0.53%, the Treasury to yield 0.65% (+3bp) and the Gilt 0.22% (+2bp).

Spread markets closed the week amid a little further weakness. The IG iBoxx index closed at B+207bp (+1bp on Friday), which was 10bp wider in the week. Sterling IG credit continues to outperform though versus the euro-denominated market, the index now at G+215bp (+0.5bp on Friday) or +8bp last week and that comes even after a few, rare deals in primary of late.

Elsewhere, in high beta land, the AT1 index moved sharply higher and is now B+957bp (+25bp Friday) representing a 62bp move wider for last week.

Finally, HY markets curiously are hanging in there. They are performing really well, the index just 3bp wider on Friday at B+676bp and only 14bp wider the week.

So it looks as if IG is under pressure because of the huge amount of issuance/investor indigestion forming. The AT1 market is feeling the pinch from the potentially weaker recovery dynamic – loan losses, falling asset prices, while the high yield market sits somewhere in between awaiting the form of the eventual recovery.

For the week ahead, in the UK we have unemployment, CPI, PPI, retail sales and flash PMIs. In the Eurozone, we are a bit lighter with inflation and flat PMIs as well with the latest Zew index from Germany. The US furnishes us with several Fed testimonies and also flash PMIs across services and manufacturing for May in an overall lighter period for market economic reports.

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.