6th February 2018

Fighting back

iTraxx Main

49.4bp, +2.9bp

iTraxx X-Over

255.6bp, +6bp

10 Yr Bund

0.70%, -3bp

iBoxx Corp IG

B+85.2bp, +2bp

iBoxx Corp HY

B+292bp, +10bp

10 Yr US T-Bond

2.77%, -0.2bp

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″]

Just watch and wait…

Equities have slumped because the market was finally fearful of higher rates. So what next? Into the equity sell-off, investors are buying rates on a flight-to-quality trade – without understanding that rates are going higher anyway. Before it was the least worst investment, now it is about capital preservation.

So, until we get some calm, cash is going to be king. And amid all the carnage, we woke with deals on the screens (albeit SSA)! Where’s the experienced syndicate manager suggesting holding off to borrowers and investors given the large market correction (it is a correction, in our view)?

After all, any investor passing on a deal into such elevated levels of market uncertainty and volatility will be forgiven if that deal rallies. There’s always the next one. But an investor who buys – and the price subsequently drops, well…

This is not the big one. That might be some way away. We continue to believe that this current equity market sell-off is a correction after weeks/months of equity market exuberance which has taken in a multitude of record highs being set in the US.

For credit investors, staying sidelined is totally the right policy. Our product is not in danger of recording wholesale – or any default, as a results of this equity-centric sell-off. Prices might move lower in some cases depending on how equities play out over the next week, but in a sense corporate bonds are still a ‘safe-haven like’ investment. Admittedly, the high yield Algeco Scotsman deal has failed to get priced on Monday (did on Tuesday), but that makes complete sense as investors pulled back and took a wait-and-see attitude…and then forced the company to make some adjustments to the pricing terms of the deal.

It will be tempting for many corporate bond market investors to try to lift some paper, given that prices will be lower in most sectors. But the Street will only work an order. The defensive bid and no offer side liquidity leaves investors fishing around for paper extremely frustrated. And we believe there are few sellers around. The salutary lesson in the credit markets over the past decade has been only to sell if completely sure. To buy back or replace a bond is likely going to be extremely expensive given the poor secondary market liquidity. Don’t kiss corporate bond positions goodbye too easily.

So what next? Watch and wait. Calm will soon return and confidence will be restored. Equities will start to look cheap again and buyers will emerge. As they rise, it will be business as usual elsewhere as that confidence returns. Primary deals will flow, spreads will tighten, macro will be unaffected by this wobble and we will likely anticipate higher levels of caution from the Fed and ECB as the hawks take a bit of a back seat. No one is going to jeopardise this economic recovery just as it seems to be finding some solid foundations.

US markets whipsaw – volatility stays elevated

The headline writers were having a field day. But the market reaction, all being told, looks to be extremely measured in our view following the large drop in stocks on Monday. After so many months of consistent rises in US equity markets, a 4-5% drop or so in a session was always going to be big news. Just because we are not used to seeing it.

On Tuesday, the European markets spent the morning session shell-shocked and playing catch-up following the extended overnight losses from the US. But no more. Equity markets in Europe were generally trading down in a 2 – 2.75% range, while US index futures were pointing to a weak open – and the VIX spent the morning session up at 50% (averaged 11% in 2017). As it turned out, European stocks took a leg lower again just before the close and finally the FTSE closed 2.75% lower, the DAX and CAC both at 2.25% lower.

Rate markets were better bid although yields didn’t collapse under the weight of demand, leaving the Bund yield at 0.70% (-4bp) and the US Treasury 2.77% (-2bp), both for the 10-year benchmark.

The US markets eventually opened sharply lower again, but managed to recover fairly smartly and that helped European stocks bounce off their session lows too. It was the choppiest of sessions though as the various US indices dipped in and out of the red as the markets tried to find their feet, even gaining up to 2% at times. The Dow closed up 2.3%.

As for the VIX, it eventually played out in a 25 – 50% range, ending at around 30%.

Credit weaker, but by no means out

Credit continued to hold relatively firm. Even the synthetic iTraxx indices came back sharply from their session’s worst levels. Main was higher at 49.4bp (+2.9bp) and X-Over rose 6bp to 255.6bp having been 15bp higher.

The deals which got away took in a covered issues, Finland printed €3bn while Greece was sidelined, waiting for the volatility to subside before it returns to the market. There was nothing in corporates save for that Algeco Scotsman high yield deal, postponed from Monday’s session.

The Markit iBoxx IG cash index finally moved higher by more than the obligatory 0.5bp or so as it widened to B+85.2bp (+2.4bp). No panic, no material selling, but a very defensive bid for any selling cares. And the same went for the CoCo market with the index 11bp higher at B+337bp – after a widening of 15bp on Monday – and leaving this index just 25bp tighter this year (versus 75bp a week ago).

The high yield market had that Algeco Scotsman deal, but little else. Unfortunately, that equity market weakness finally filtered weighed on high yield valuations. Although flows and volumes were very light, the secondary markets illiquidity saw to it that spreads gapped and the index widened by a massive 10bp to B+292bp. That’s 6bp wider this year having been 24bp tighter a week ago.

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.