3rd March 2020

🏦 Fed blinks, wastes a bullet

iTraxx Main

64.2bp, -3.9bp

iTraxx X-Over

288.9bp, -20bp

🇩🇪 10 Yr Bund

-0.64%, -2bp

iBoxx Corp IG

B+126bp, -2bp

iBoxx Corp HY

B+421bp, -18bp

🇺🇸 10 Yr US T-Bond

0.96%, -12bp

🇬🇧 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″]

Rate cuts aren’t gonna cure Covid-19 (sadly)…

Textbook stuff. Markets collapse > Word emerges that the central banks are going to cut rates > Markets rally > Investors look to get ahead of the curve and buy into it. In credit, the primary window opens and a few nimble operators get some funding away. And so another crisis event falls by the wayside.

Throwing greater levels of liquidity at any problem seems like it will do the trick. It’s worked every time over the past financial crisis-ravaged decade. Anyone would think that cutting rates/pumping the system with more (cheaper) liquidity is the Covid-19 cure.

The Fed obliged anyway, as it cut 50bp off the Fed Funds rate. The move took the markets by surprise with timing of the rare emergency action, coming just a week after suggesting patience was required. And sold off.

Hmm. What’s happened in that time to provoke such a response? The suspicion around saw US markets decline by 1% after the cut and European equities retreat from their session highs.

Few are comforted by it. The communication of it could have been better handled. Dare we believe another one is coming in a couple of weeks at the next FOMC?

So, is this a signal to sell? Easier policy is designed to keep the financial system afloat until we pass peak Covid-19. Buy into that and we have an answer as to a rally taking us out of any inflexion period. The flip side is that lower rates only help at the margin and the market’s exuberance was irrational.

The reality is that the ECB doesn’t really have any effective bullets left. The US Fed, however, could cut some more and that might keep prices propped up for longer than we think. That’s the theory which didn’t quite pan out on Tuesday.

We think easier policy, though, is coming from the ECB now as well – not least because the markets expect it, and we are staring a volatile period in the face. Eventually, a crooked ‘U’-shaped recovery it is going to be.

After a more tentative European upswing on Monday, we had only a moderately better session on Tuesday, largely as a result of the 5% gain overnight in the US. We came off the session highs after much concern as to that dramatic Fed rate cut.

US stocks sold off hard and were up to 3.3% lower as at the time of writing. Rates went better bid. Gold shot higher again. This is scary stuff.

From 1.14% on the US Treasury 10-year yield to 0.96% in a flash (-12bp in the session). That’s a record low with the 30-year at 1.58% – also a record low.

The 10-year Bund yield reacted similarly, with the yield dropping from -0.56% earlier in the day to -0.64% (-2bp). That will be through -0.70% on Wednesday. That G7 concerted reaction pretty much tells us that a rather limp ECB is going to be called into action.

The BoE might be only one staying pat for the moment. Gilts rallied, though, and the yield on the 10-year declined to 0.37% (-4bp). The follow on from the Treasury bid will see Gilt prices rise on Wednesday and yields on the 10-year through 0.30%.

Primary opens, but likely proves temporary

Surprisingly, primary re-opened. The gap was spotted and a couple of corporate borrowers took full advantage. And the demand was as good as ever, suggesting that few are deterred by the current market valuation machinations borne form illiquidity and a defensive Street bid. It’s difficult to tell if the window stays open now after that cut.

Anyway, we had a three-tranche deal from RELX and a dual-tranche offering from Honeywell. The former issued a combined €2bn with €700m of it coming in a 4-year at midswaps+60bp, €800m in an 8-year at midswaps+90bp and €500m in a 12-year at midswaps+110bp. The combined books were up at €11.2bn and final pricing 25bp inside the initial talk across the tranches.

As for Honeywell, they issued €500m in a 4-year maturity at midswaps+50bp and €500m in a 12-year at midswaps+90bp, off books up at €6.5bn and final pricing also 25bp inside the opening guidance.

Into the broadly risk-on session with equities displaying recovery, the cost of credit protection fell and iTraxx Main was 3.9bp lower at 64.2bp while X-Over insurance dropped to 288.9bp (-20bp).

In the cash market, we saw the first tightening in spreads for almost a couple of weeks, but just 2bp better (B+126bp) for the IG index. The AT1 index crunched 30bp tighter to B+458bp and the high yield index was 18bp better at B+421bp. That’s all a good demonstration of the illiquidity in secondary markets.

Look for all that performance to go the other way on Wednesday.

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.