2nd February 2020

❔ The Big Question

iTraxx Main

46.4bp, +0.5bp

iTraxx X-Over

231.2bp, +3bp

🇩🇪 10 Yr Bund

-0.44%, -3bp

iBoxx Corp IG

B+105bp, unchanged

iBoxx Corp HY

B+367bp, +3bp

🇺🇸 10 Yr US T-Bond

1.51%, -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″]

Twin-pronged attack…

The coronavirus rages and is finally having the impact on the markets that the headlines warrant. It could already have been a lot worse.

In part, that has to be due to the US earnings season which has been mixed, but has seen the likes of Amazon hammer expectations and offer a small brake effect to try and limit the downside. Unfortunately, from here, the virus’ impact is likely going to get worse.

The narrative for February will be dominated by the spread of the infectious disease and how that will the impact global economy. It doesn’t look great at the moment, as more and more cases and deaths are reported. Some markets managed to hang on, by their fingertips, to gains in the opening month – but that dynamic is unlikely going to persist through February.

That’s because there is going to be a significant hit on global growth.  For example, Eurozone growth – already weakening from the trade war as seen in the Q4 data – is going to come under further pressure throughout the first half at least. Recession looms large.

It’s suddenly no longer a big call to be looking at 10-year Bund yields in the context of -0.60% (-0.44% now, -0.20% at the beginning of January). Who would have thought?

It means that corporate bond market investor strategies ought not to change. If anything, they are more cemented with investors likely continuing to allocate cash into the corporate bond market. They will have looked at last year’s returns and those from January, and feel the need to still park up in the asset class. Primary activity will falter, though.

The bid for safe havens (rates) and the big drop in yields has the incremental yields offered from the corporate bond market well sought after. The $64,000 question is whether the emergence of the coronavirus on the global stage materialises into the cliff-edge catastrophic financial system event.

We think not. But it is an extremely difficult situation.

Away from the coronavirus situation, we are into Brexit territory proper. That will bring its own level of headline risks and potentially some volatility across European markets. We’re going to see that rise likely into the June/July period – deemed as the crucial point at which some kind of deal needs to have been fleshed out. If not, we will need to be braced for a difficult period towards the end of the year.

Mixed primary

The IG non-financial primary market has disappointed in January. Just €20bn was issued. We had hopes that €30bn+ would easily be achieved. Certainly, the demand was there for even €40bn to get away without any impact on the pricing dynamics – 20bp or more of tightening versus the initial price guidance and interest of 3x or more for deals.

The month was obviously hit by a couple of periods of serious event risk and the subsequent volatility might have contributed to the lower levels of issuance. Not that it had any impact on the senior/high yield markets which recorded excellent levels of deal flow.

A more credible explanation would be that the supply in 2019 smashed previous records (€318bn issued versus the previous record of €271bn in 2016) and borrowers just have less to do.

January is always a heavier month for issuance in senior financials. However, the €31bn printed was the third-best month for issuance since 2014. We would think that the welter of issuance will fade some through the next few months and, of course, much will depend on broader headline risks as well the developments in global macro.

€164bn was issued in 2019, we think somewhere around that level is still likely in 2020.

High yield on top

The pick of the sectors, from an issuance perspective, has been the high yield market in January. Usually, the high yield market is a very slow starter. Not this year.

The month’s volume of over €13bn marked it as the third best in the history of the high yield market in Europe. And it went against the grain completely in the sense that on any other occasion where we have the level of headline risks and associated market volatility, the high market has promptly closed.

This augers well for borrowers. It highlights the high level of investor cash looking for a home in the market. Few are chasing secondary. The ECB is probably back to crowding out investors in the IG market through is QE-related programme. It’s early days, but we will not be betting against a record year for issuance.

Coronavirus and weakening growth to hit markets

We kick off February with alarm bells ringing. News that the coronavirus has finally turned up in the UK. That’s something for equity markets, and they will have a defensive bias about them. Brexit is also now in full flow and it is all about what trade agreements, if any, can be forged between the various protagonists. Expect volatility.

The Eurozone barely grew in Q4, just 0.1% versus Q3, but the French (unexpectedly) and Italian economies shrank in the quarter – by 0.1% and 0.3%, respectively. Eurozone annual inflation increased though to 1.4%, up a touch month-on-month, but the core rate slowed to 1.1% (1.3% previously).

As stated, growth is under some conservable pressure and concern at the ECB and BoE will likely lead to some action soon. The next ECB policy gathering comes perhaps a touch too early on 19th February and they will want to see more data, we think.

Time for action might be more appropriate at the 12 March meeting. But the BoE’s monetary policy committee next gather on 26 March. They will have plenty to chew over by then, and a 25bp rate cut could well be on the cards.

January ends badly for equities

It’s not any surprise that we eventually closed January on the back foot. Another session of big losses on the final day of the month in equities, as the coronavirus spread escalated, meant that European equities dropped deeper into the red for the month.

The S&P500 was gutted and also gave up the ghost. And all that after most bourses had set record highs across the board just a couple of weeks into the New Year.

In the eye of the virus storm, the drop in equity markets had us close January with the FTSE off by 3.4%, the Dax losing 2% and the €Stoxx50 -2.6%, all performances for the month. In the US, the S&P succumbed but was only just in the red in January while the Dow was off by 1%.

In cash credit, it’s been much better. Spreads, as measured by the iBoxx index, are 2bp wider in the month and total returns for the asset class up at 1.1%. Few will kid themselves, well aware that the positive return is largely driven by the rally in rates. However, even into that market weakness in the final session of the month, the high beta AT1 market remains resolute with spreads unchanged at B+376bp (-20bp for the month).

In the UK, the sterling market has also been resolute and has shown no sign of weakness, let alone panic. The iBoxx index in IG was 4bp tighter in the month, and total returns up at 2.4% in January.

Elsewhere, the euro-denominated high yield market closed the month with spreads 22bp wider but returns up in the black – just, by +0.3%.

And all of the above in fixed income – or credit, rather – was made possible because of the rally in rates. Here, Eurozone rate market investors, as measured by the iBoxx index, are sitting on total returns for January of 2.5%.

Coming up next

We’re not sure how primary will evolve this week, but we would side towards there being some issuance unless we get a severe down day (or more) in equities. Risk off/on’ish will keep the window open.

The data takes in manufacturing PMIs in Europe and the US all on Monday. We have Eurozone PPI and services PMIs midweek, before finishing off with US non-farms (156k additions consensus) as well as Chinese import/export data for January.

On the US earnings front, we slow a little but it’s Google (or rather, Alphabet), Disney, Ford, GM, Spotify, Philip Morris, Uber and Twitter for example amongst those still to come.

After all that, the reality is that we are going to be watching the headlines and trading around them. The path of least resistance is for lower equities, a sustained bid for safe-havens while credit fits somewhere in the middle of all that.

We will see spread weakness but the rally in the underlying will serve as an offset, boosting total returns.

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.