9th March 2020

📰 Why you shouldn’t buy this dip!

iTraxx Main

104bp, +25bp

iTraxx X-Over

460bp, +90bp

🇩🇪 10 Yr Bund

-0.86%, -13bp

iBoxx Corp IG

B+169bp, +30bp

iBoxx Corp HY

B+562bp, +94bp

🇺🇸 10 Yr US T-Bond

0.51%, -19bp

🇬🇧 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″]

Offered only, no bid, spreads gap… any hope?

The worst of days for the markets. Commodities, equities, credit all hammered and rates/safe-havens bid up. The Covid-19 story is not even close to being over, but how much have the markets already discounted? Some will think not enough, others will have an itchy finger (to buy).

Mind, the day’s lurch lower was more driven by the House of Saud’s declared trade war with Russian oil which will now very likely tip the global economy into recession. That 30% oil price cut by the Saudis has demonstrated that it has now become a case of every man and woman for themselves.

In terms of a policy response, urgency is required – as is the need to think outside the box, because the coronavirus’ spread is the global economy’s ‘The Emperor has no clothes’ moment.

It will be revealing in many aspects, from the unraveling of globalisation (interconnected economies, supply chains etc) to the dismantling and possible collapse of our highly indebted markets – the latter will expose the fragile structures of the financial system borne from the crisis since 2008.

The cards are tumbling, and it would appear that the Fed is a nailed-on certainty for another 50bp cut next week. Whether they want to or not, the ECB will have to cut as well (meet on Thursday), likely increase the size of QE purchases and adjust the TLTRO. As well a being all very orthodox, it won’t make any noticeable difference.

The ECB will not take any additional further draconian measures. To ease the economic risks and rising financial burdens, fiscal loosening will be necessary across the board. Maastricht government borrowing and debt criteria will need to be suspended, albeit temporarily – and there were signs during the day that this was being considered.

Not constrained by the Maastricht shackles, the UK Chancellor’s budget this week ought to be as profligate as possible, for example – the UK is effectively being paid to borrow, after all. The 10-year Gilt yield dropped by 15bp to an intraday record low of just 0.08%.

We’re now in coronavirus pandemic territory, it’s just a matter of days (if that) before the WHO officially calls it. Even if they don’t, the economic damage is being done. And it’s close to the worst-case scenario as large swathes of Europe is heading into forced lockdown to try and contain the spread of the virus.

Even after Monday’s disastrous declines, we must be looking at further material falls in risk asset pricing. It’s incredible to think it, but equities have more to fall. High yield markets look as though spreads will gap further and any recovery potentially laboured – when it comes. The same goes for the AT1 market and much other high beta credit risk.

We’re now thinking in terms of the 10-year US Treasury yield going into negative territory. Trump will be flapping. That -1.0% yield on the 10-year Bund yield – our oft-cited target, is in throwing distance, while the next stop sees it possibly heading for -1.25%.

Don’t go buying this dip, not yet…

Dare we look on the bright side? High yield markets will be hammered and low beta markets will be under immense pressure as well, but we can view the credit/spread dynamic from a different angle.

Of course, spreads will go significantly wider, even from here. But there is underlying support from the IG corporate market as a result of the portfolio cash balances still looking for that home in a fixed income asset which is yielding something positive – versus the declining/negative yields across much of safe-haven government curves.

And while we’re going to see a battering in some sectors/specific entities in equities (airlines, travel etc), the IG credit aspect of particular corporates suggests an underlying ability for them to withstand a temporary cull in revenues/cashflows/profits. There will be downgrades, but high levels of cash balances will help buffer the worst of it. They can and most likely will bounce back, in most cases.

So credit protection is currently the most efficient way to hedge portfolio risk against the weakness in cash spreads, and we’re seeing that as costs rocket (read more below). Hopefully, paying out that protection premium is going to be as temporary as the Covid-19 spread.

Crash, bang, wallop

Markets managed to close off their worst levels for the session. While the moves anyway were big, one can’t help thinking that there are more big moves to come. The constant drip-feed of regional lockdowns and then the potential for event-risk like the Saudi oil price cull, suggests there are more shocks awaiting us.

Unfortunately, highly leveraged shale gas producers, having such little financial flexibility are going to go bust. That will feed into the US corporate default statistics. Confidence and money will shift away from the high yield market and exacerbate the price collapse there. That will reverberate elsewhere – probably everywhere.

Cash credit investors can just watch and wait – and buy protection. There is no reasonable clearing level anywhere across the market. Hence the scramble to buy credit protection. The synthetic indices lurched higher, iTraxx Main was up at 104bp (+25bp) and X-Over rose by 90bp to 460bp.

The cash market is trading its own version of the lockdown. Extreme weakness and really nothing doing. The primary market window is slammed shut, boarded up and we’re not anticipating a deal outside of the SSA/sovereign/covered bond space anytime soon. And, even for these markets, we’re going to require some calm. Secondary cash was well battered, but the price action at the close reflects that inability to find a clearing level of any sort.

So the IG iBoxx cash index closed at B+169bp which was 30bp wider -with the likes of autos, metals/mining, airlines and oil & gas company debt feeling the brunt of it, up to 150bp wider. Senior financials moved up to 60bp wider with Italian bank debt much more.

AT1 paper was up to 4-points lower (core) and up to 6 points off elsewhere with the index a massive 145bp wider at B+664bp as fears of a forced regulatory coupon suspension mounted. The HY index also collapsed, widening by a stunning 94bp to B+562bp.

Unfortunately, equities will more than likely move lower from these levels as each Covid-19 headline hangs over the markets like the proverbial Sword of Damocles. That’s after we closed out in Europe with declines of as much as 8.3% (€Stoxx50), which was only a shade off the worst levels for the day. The FTSE closed 7.5% lower and the Dax 7.9%. Italian markets tumbled by 11%.

US markets were around 7.8% lower at their close. Brent was 22% lower at $33 per barrel, with even Bitcoin feeling the chill, now at $7,800 per coin (-7%).

In rates, the market went completely bid-only across safe-haven government bond markets. We saw that collapse in yields with the 10-year US Treasury 14bp lower at 0.56% – and off the intraday low of 0.31% (!). The 30-year US Treasury visited a yield of just 0.70% before ‘recovering’ to 1.03% (-18bp in the session). Panic? Definitely.

In Europe, we saw a record low -0.86% in the 10-year Bund yield (-13bp) and 0.08% as mentioned in the Gilt yield for the same maturity – but up at 0.17bp at the close (-7bp). The rates markets have pencilled in recession, rate cuts and other easing measures to boost global liquidity conditions.

The US markets will hold the key. If the coronavirus’ spread is contained and well-handled in the US  then we might not see the worst. The early signs are that it won’t be handled well, so hold on.

Unfortunately, in times of crisis, attention will shift away from saving the planet. Green energy just got very, very expensive.

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.