27th February 2017

Fabulous February

FTSE 100
7,244, -28
11,804, +144
S&P 500
2,367, +4
iTraxx Main
75bp, +1bp
iTraxx X-Over Index
296bp, +2bp
10 Yr Bund
0.18%, -6bp
iBoxx Corp IG
B+137.8bp, +0.5bp 
iBoxx Corp HY Index
B+380bp, +2.5bp
10 Yr US T-Bond
2.31%, -6bp

A quality problem…

The optimism around macro as seen through the eyes of the equity markets in February has not been shared by the government bond markets. They’ve both rallied – but they can’t both be right. It’s obviously not that simple but some sort of rising tide has lifted all boats through this month. We have 2-year Bund yields at record low levels and approaching -1.00% (!), a US interest rate hike is coming soon but treasuries and equities are rallying – the latter setting new record highs all too frequently. And it is not a case of low rates for longer offering (psychological?) support.

The story goes on. The 10-year Bund is yielding 0.20%, having recovered in price to more than halve the 0.48% yield high for 2017 seen exactly a month ago. Gilt yields in the 10-year maturity, for example, have also dropped from a 2017 high of 1.51% to 1.08% while equities have risen. Meanwhile, the UK economy has had a decent time of it since the Brexit decision was made some seven months ago.

Avery Dennison: €500m 8 year deal on Friday

We’re not going gangbusters on macro, but the outlook isn’t necessarily as dim as those yield moves through February suggest. Admittedly, we have QE ongoing from the ECB and the BoE doing its manipulative best, but there are few signs from the fixed income markets that all is rosy.

So we come to geopolitics. And that’s what it must be. “Trump” is becoming untradeable, while we can probably view that some of the improved bid for government bonds is due to the forthcoming French elections. There is a level of uncertainty around them which is likely enough for investors to hedge their risk with some safe-haven assets.

Mind, the credit markets have hardly been all guns blazing, with spreads versus benchmark wider in the month and primary close to being a busted flush with the lowest level of IG non-financial issuance for several years in February – into extremely receptive markets. Throughout the eight years of crisis, there has been a sustained good bid for credit, but more recently that’s failed to follow through into tighter spreads versus government bonds. We should be looking at record low spread levels but we are not. That’s one we can’t quite work out.

Sanity and logic make for poor bed fellows for bond market traders/investors these days.

There is much sidelined cash. Credit fundamentals remain rock solid. Corporate bonds were once viewed as a safe-haven asset class offering a spread/yield pick-up versus low/negative yielding government bonds. Admittedly we’re bereft of secondary market liquidity – but that isn’t stopping the ECB lift €2bn of IG non-financial debt per week!

Issuers can get great funding levels still, as evidenced by Friday’s deal from Avery Dennison where the borrower raised €500m in 8-year funding at midswaps+80bp and managed to cull the initial price guidance by some 30bp. What more do borrowers want?

High beta credit looks cheap here.

Classic bond/equity trade-off to end the week

The week actually ended on a sour note for equities but a sweet one for fixed income investors. We have a couple of sessions to go before we close out this month – which has been a super recovery one for bond market players, and we’re looking for little to change through the sessions which might derail the month’s overall performance. Non-farm payrolls are up on Friday and so we will likely witness a shorter week (activity-wise) given that today and tomorrow will be about squaring up portfolios and assessing month-end valuations.

The strategies through March ought to be much the same, except we might think that primary corporate activity will pick up ahead of any potential for volatility into the late April first round of the French elections.

In the markets and, as stated above, 10-year Gilt yields were down at 1.07% (-9bp) in Friday’s session, the 10-year Bund yield closed down at 0.18% (-6bp) with the 10-year OAT yielding 0.92% (-5bp). These were strong rallies in the government debt markets. The German government bond curve is now showing negative yields up to eight years again. By contrast, equities had a couple of weaker sessions to close the week, down up to 1% in Europe on Friday – but they’ve had a very good month overall.

Credit spreader wider, returns zooming higher

In secondary credit, we closed wider for choice. There was little by way of activity and that left the Street holding defensive bias as equities pushed lower. As measured by the Markit iBoxx IG cash index, that spread was up at B+137.8bp (+0.5bp) although the index yield dropped to 1.09%, leaving returns YTD at 0.7% and a clear recovery from the negative returns in the month to end January.

The sterling corporate market edged tighter (by 0.5bp on index) while the large Gilt rally helped push returns materially higher, to 1.4% so far this year.

There was weakness in high yield too, with the iBoxx index up a couple of basis points to B+380bp but returns are higher, up at 1.6%. Finally, iTraxx Main closed at 75bp (+1bp) and X-Over at 296bp (+2bp) and weaker in line with the day’s risk-off sentiment. US stocks managed to close in the black and that should auger well for the open today.

This week sees US GDP and manufacturing data, Trump’s televised congress testimony and we close out with non-farm payrolls on Friday. The European earnings season is still ongoing, too.

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.