25th January 2018

ECB unchanged, but IG credit is the story

iTraxx Main

43.6bp, -0.2bp

iTraxx X-Over

232.5bp, +0.8bp

10 Yr Bund

0.63%, +4bp

iBoxx Corp IG

B+85.2bp, -0.3bp

iBoxx Corp HY

B+267.5bp, +1bp

10 Yr US T-Bond

2.62%, -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=”10″], [wp_live_scraper id=”11″]

The mind boggles…

Pfff. The IG cash market has already tightened the 11bp we thought it would do for the full-year – in just three weeks! We’ve barely had the supply we ought to have (just €17.1bn in IG non-financials) while quite obviously the demand remains extremely high. The order book for Auchan’s deal on Thursday illustrates that.

Admittedly, equities are setting records, but that ought to filter through into the high yield market. It isn’t. We’re scratching our heads as to why this tightening is so dramatic, because it has blown all expectations out of the water. Secondary is super illiquid, valuations are the richest they’ve ever been (record tights), there’s a perceived ‘safe-haven’ pick-up versus government bonds, macro is supportive and there is cash to put to work.

The corporate high yield market isn’t feeling the love, while the sensible (speculative?) money is squeezing the last pips out of the contingent convertible one. The CoCo market is a better counterweight to lower yielding IG positions than is the high yield one. But how tight can IG credit actually go? We’re at levels (as measured by the Markit iBoxx index) last seen before the last bubble burst back in 2008. And now we have that improving macro added to it by the ECB’s manipulative buying.

It is difficult to put a number on how much tighter we could go from here. After all, the macro side of the equation is very supportive, the ECB is buying debt (€134bn of it) of an illiquid market for IG non-financial securities, the low supply levels aren’t helping the situation and cash is still coming into investment grade portfolios (not to mention the high level of bond redemption proceeds).

If we look at it very fundamentally, the ability for the corporate sector to service its obligations is the best it has ever been. This is supported by the excessive levels (historically) of cash on corporate balance sheet and the still historic low level of funding costs that IG corporates continue to benefit from.

And then that Auchan offering, credit has certainly benefited from duration money moving away from negative rate government bond markets with investors happy to park their cash here. The high triple-B rated retail giant raised just €350m in a 2-year floater format, garnered an order book almost €2.5bn and priced the deal 15bp inside the opening guidance. The final price was Euribor+5bp. There’s some desperation in the market. There has to be more legs in this market.

The iBoxx IG index has tightened by over 100bp in the past 24 months, with 38bp of that tightening coming in 2017. We’re at a record tight level of B+85bp now and we’re into an economic upswing. Another 10bp of tightening? Why not 20bp?

ECB copies and pastes

Same again from the ECB

As expected, the ECB kept it all unchanged. The refinancing rate was at 0%, the deposit rate at -0.4% and the asset purchase programme at €30bn per month. And it stands ready to expand the measures if it sees fit and necessary to do so. They’re ramming home the message that they want growth underpinned with some firm foundations, and are more hopeful that inflation is on the up and will get much closer to target.

So the euro gained, to its highest level in 3 years as it went past $1.25 while rate markets generally sold off although they managed to claw back some losses. The 10-year Bund yield rose to 0.61% (+2bp), the equivalent US Treasury was up at 2.67% (+2bp) before the yield declined to 2.62% (-4bp). In the UK, Gilt yields closed unchanged at 1.41%, having being up at 1.44% (+3bp) earlier.

Dollar weakness impacts European equities

Equity markets played out in rather tentative fashion , until Draghi rebuffed Mnuchin’s weak dollar stance that the Treasury Secretary made on Wednesday. Added to that growing confidence around the Eurozone’s macro recovery and that strengthening euro, European equities took a leg lower. Having set record highs earlier this week, the Dax was off by almost 1% and was the principal underperforming index on Thursday. US stocks spent the session a small up or down, and were helped higher after some good earnings from 3M and Caterpillar.

In credit primary and apart from Auchan, we had other deals which was a surprise given the ECB holding sway usually deters borrowing activity. Anyway, Belfius Bank finally priced its CoCo, the PNC-Apr/2025, €500m deal priced to yield 3.625%, which was 37.5bp inside the guidance on books exceeding €4bn.

One of the other borrowers in the session was the unrated French group Ubisoft Entertainment which issued a 5-year, €500m transaction at midswaps+90bp. It was off a €2bn order book and eventually priced a huge 25bp inside the opening guidance. We think it should be viewed as a high double-B name.

Iccrea Banca‘s €400m deal took the senior financial supply to €20bn for the month. The Republic of Chile added to the long list of sovereign borrowers raising in euros in these opening weeks, with an €830m, 11-year deal.

It was difficult to tell whether macro or equities were dictating the direction for credit protection. In the event they ended mixed with iTraxx Main a smidgen lower at 43.6bp (-0.2bp) while X-Over edged higher to 232.5bp (+0.8bp).

The cash market outperformed again, not gyrating to the tune of European stocks which have got quite technical, but more driven by macro and demand for a ‘rate’ product offering a little more the government bonds. The iBoxx IG cash index squeezed some more to B+85.2p.

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.