5th January 2016

Frazzled circuit

FTSE 100
6,093, -149
10,283 -460
S&P 500
2,013, -31
iTraxx Main
81bp, +4bp
iTraxx X-Over Index
333bp, +18bp
10 Yr Bund
iBoxx Corp IG
B+155.4bp, +1bp 
iBoxx Corp HY Index
B+528bp, +0.5bp
10 Yr US T-Bond

Better to test it sooner rather than later… Well, it was not quite the start anyone would have expected – but at least we know now that those newly implemented Chinese stock market circuit-breakers work. That’s about the only bit of good news after the very dramatic opening day of 2016. Stocks were down by 7% in China in the session, trading was suspended and the market closed early all on the back of a weak manufacturing survey for December. Heading westwards, the shutters didn’t even go up! The most liquid of assets – equities – were routed. The Chinese drop saw to it that the DAX fell by over 4% and other European bourses by 2.5% or more. Classically, the flight-to-quality trade didn’t always turn out as one might have expected in 2015 during periods of stress, because all risk assets came under pressure simultaneously. But this time Bunds and other government paper caught a solid bid and yields headed lower. We may have drawn a line in the sand for New Year, but it’s the same old story. The economy and Middle East geopolitics dominate, although weak German inflation data (or not as the case might be) will have the ECB casting a worrying glance and once again looking at its burgeoning shopping trolley (more QE?). UK and US manufacturing PMIs came in weaker than expected. Even the spike in oil prices on Saudi-Iranian tension was short-lived, and again touched those multi-year lows. So foremost in our minds through January will now be the three Fates of Chinese manufacturing, growth and policy, which will dictate any subsequent impact on global growth. The slower moving credit market was just slow. Defensive, little trading going on, no bid, no supply and a shell-shocked asset management community wondering if their investors will pull the plug and move into cash, or stay with it and clip the coupon through what promises to be a squeaky bum time of a January.

Illiquid markets seeing unforgiving pricing action… Don’t say you were not warned. Much has been said and written about market liquidity (the ability to trade at a reasonable price in your size), and price action like that witnessed in Monday’s session ought to have been avoided. After all, China’s slowing should not elicit the sort of reaction it did: all reasonable observers expect that it will slow this year. One swallow doesn’t make a summer, but… as it happens, the manufacturing sector has now declined for the fifth consecutive month, forcing the People’s Bank to manage the currency lower again in response. Middle East politics are a hot potato, but we think they took a back seat to the main reason for the equity (and credit market) weakness. For credit, poor flows and low volumes in an already massively illiquid secondary market meant there was no escape route. We had to take it on the chin at the opening bell. One is either a believer in these markets or not: you cannot be a trader – so don’t be. However, now is not the time to panic, because the Street bid for any desperate selling cares will be eye-wateringly painful. We suggest riding out the storm, letting the market calm, and if still worried then perhaps selling into some strength to bolster cash positions in anticipation of fund outflows.

Sea of heartache… The DAX dropped by 4.3%, the CAC by 2.5% and in the US, the Dow Jones by 1.6% and the S&P500 some 1.5% (off the worst levels of the session by far). The Bund was bid up, with yields dropping to 0.57% (-6bp on the 10-year), while the 10-year US Treasury yield fell to 2.24% (-3bp) and all the curves flattened. The euro perked up against the dollar to just below $1.08, while Brent crude ended a touch higher at $37.31 and WTI dropped to $36.78. Gold was up by just over 1%, but the likes of copper and aluminium were lower. All classic flight-to-quality/safety trades. In credit, it was a day to watch the screens and mark the books “somewhere lower”, given that price visibility was non-existent. For the iTraxx indices, we saw Main better bid and up at 81bp and X-over at 333bp while the cash indices only saw very modest weakness with the Markit iBoxx IG corporate index at B+155.5bp and the HY index at B+528bp.

Here’s hoping for a dead-cat-bounce at minimum. 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.