27th January 2019

Event-risk fraught week ahead

iTraxx Main

74.5bp, -2.3bp

iTraxx X-Over

321.5bp, -8bp

🇩🇪 10 Yr Bund

0.19%, +1bp

iBoxx Corp IG

B+166.5bp, -2.3bp

iBoxx Corp HY

B+497.7bp, -5bp

🇺🇸 10 Yr US T-Bond

2.76%, +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″]

Yield is the key in 2019…

Equity market valuations, when taken in isolation, seem to paint a picture that the macro outlook is bright…or that equities are cheap because rates are going nowhere. The earnings season is upon us and the flow of reports has been quite mixed, but the equity market is looking sprightly. In the meantime, there is no sell-off in rate markets as broad macro economic weakness is underpinning the support for fixed income product. That benchmark 10-year Bund yield is going to struggle to get anywhere near 0.50% this year (currently sitting at 0.19%). If it does, it’s going to need a smooth or no-Brexit, a US/China trade agreement, and a recovery in Chinese and US growth levels closer to 7% and 3% in 2019 against the forecasted 6% and 2%, respectively. Indeed, we don’t see it either.

In a sense, it is difficult to see how the economic slow down that we are in cannot get any worse. Business and consumer confidence drops with each monthly survey and investment levels are declining We’re sitting on a lower level of corporate profits as the global economy starts to run out of steam and consumer spending declines, while we haven’t addressed the high levels of global indebtedness borne from the expansionary central bank policies of the past decade.

Policy makers will be pushing on the string some more, in due course. So it makes sense that in credit, for example, we are seeing a good bid for yield. That BCP, a weak heavily indebted and still fragile financial institution managed to get the most subordinated of capital instruments away last week suggests as much. AT1 paper is designed to fail. And there is already a growing expectation that Santander might not redeem their upcoming AT1 issue at the call date. That would be a first and the market is watching.

But it’s January. Credit investors have cash to burn. Inflows are good and investors traditionally are much more forgiving of borrowers at this time. Investors also want to record some early performance while the going is good. Store up some good will (performance in the bank in case needed later), if you like.

That’s why the primary window is open. We have had deals, but we could have more, and higher beta corporate borrowers should be much more prevalent in the market than they are.

So we might be bearish macro, but we don’t see economic cliff risk. The ECB is moving slowly, the Fed will too. They will try to assuage any market concerns with words (dovishness) before they might be needed to take action. We also think that market rates are anchored around these levels for the foreseeable future. The default rate isn’t going to suddenly pop higher. Rating transmissions risks will emerge slowly.

The equity/rate market is dislocated – and credit makes sense right now.

Primary window open

So Friday’s corporate bond deal flow took in only a €500m 10-year Tier 2 offering from CNP Assurances at midswaps+215bp. Overall though, it was a good week for IG non-financial deals, although we only spurred into life on Thursday with two 4-tranche offerings from IBM and VW for €5bn and €2.5bn, respectively. The weekly total came to €9.1bn with Auchan and Accor being the other borrowers. For the month as a whole, we are now up at €23bn.

As for this week, it is difficult to gauge how busy we might be, just as we didn’t really expect such offerings in size from the likes of VW (again) and IBM last week. There should be transactions, though, as that primary window is wide open and after Friday’s positive equity markets (for whatever reason), borrowers should take it as an opportunity to get some funding in.

The high yield market is yet to see a more ‘traditional’ offering. We’ve only seen blue chip peripheral industrial fallen angels populate the primary sector (TIM and EDP/hybrid), but if the sentiment remains positive we should expect a deal or so to be added to the tally (€2.25bn). Also, after that flurry of issuance in senior bank debt through the first two weeks of the year, we had just a couple of senior prints last week (KBC, Citigroup) leaving the total  for the month at €16bn (versus €21bn January last year)

Big week ahead

There was hope that the Fed would reduce the pace at which it is deleveraging its balance sheet and it helped to boost equities, while news that Trump had agreed to temporarily end the government shutdown also helped to underpin sentiment and risk markets. US equities ended 0.9% higher, the Dax added 1.4% with gains across the board except for the FTSE, alone hampered by the rallying sterling.

Rates gave a little back with the 10-year Bund yield up at 0.19% (+1bp), the Treasury yield up 5bp to 2.76% and the 10-year Gilt yield backing up to 1.32% (+2bp).

In credit, the synthetic indices were better offered (lower) which was to be expected given the tone generally was positive, and Main closed 2.3bp lower at 74.5bp while iTraxx X-Over closed at 321.5bp (-8bp).

The cash market wasn’t to be left behind. The squeeze continued here and the IG iBoxx cash index moved 2.3bp tighter to B+166.5bp, leaving it 6bp tighter since the beginning of the month and 12bp off the wides seen less than 2 weeks ago. That’s some rally, helped by a primary market still not firing on all cylinders.

Of course, the high beta CoCo market is feeling the warm glow that comes from the current positive tone, and the index moved 18bp tighter to B+614bp, and this is the lowest level for this index since mid-November. Returns exceed 3% so far this month. In high yield, the index edged just 5bp tighter to B+497.7bp with returns sitting at 1.6% for the month.

As for this week, the Brexit debate in the UK sees the Commons voting on a Plan B as well as various amendments put forward by MPs. The FOMC concludes its first meeting of the year on Wednesday and we must be expecting nothing but a more dovish stance from them. The trade talks will resume between the US and Chinese delegates while the earnings season moves up yet another gear as Apple, Tesla, Amazon and the likes of Boeing, Caterpillar and Pfizer are all due. We close out with January’s non-farm payroll report (160k expectations).

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.