- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
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Shaking all over…
It was a horrible end to the month which eventually saw us lose most (if not all) of our performance – from a total return perspective anyway. No crisis. No panic. And no major catastrophe. But a seemingly major reassessment of where we are following comments by the big three – Yellen, Draghi and Carney.
It promises to be a long summer for some. Equities lost a little of their mojo but, as we are well aware, they can recover hard – and quickly. The big one for us in the corporate bond sector is around rate markets and where they’re possibly heading. Fixed income has had a good old battering of late, with yields ratcheting higher on the fear (believe it or not) of economic recovery!
Mind, while government bond market investors might have been losing their heads amid implications of what that recovery might entail on the policy front (QE tapering etc), corporate bond market investors were not. That might eventually come, but a material widening in spreads in our market aren’t the first port of call on the weakness stakes when we might be heading into a sea change on the macro/policy fronts. Admittedly, market liquidity isn’t helpful.
With the margins being much smaller and the market being of longer duration than the high yield one, returns in the investment grade market for the month of June have been lost into that rate back-up through the end of last week. Credit spreads have been resolute into the rate market weakness, which is a big surprise. Fundamentals would justify that being the case but we have rarely (if ever) had such a back-up in rate markets and credit was left untouched by it. They move in tandem in extremis.
Going into the last week of June, 10-year Bunds were yielding around 0.24%, the equivalent maturity Gilt 1.00% and the US Treasury around 2.15%. We’ve come out of that week, now at 0.47%, 1.26% and 2.29%, respectively, amid a savaging at the end of last week in the rate markets. IG spreads and even those in the high yield market were unmoved by those rising yields – and that includes even after equities also came under some pressure.
So, for now, credit stays resolute with investors not panic-selling as the markets elsewhere find new levels, reconciling valuations in equities and the potential for policy adjustments eventually elsewhere.
Cash credit market resisting for the moment
Usually when we have a risk-off period, the first to react for credit are the now well-established iTraxx indices. They’re the illiquid cash markets’ liquid proxy and used to hedge the potential for any (eventual) weakness in cash. iTraxx Main was up at 56bp at the close on Friday (+2.4bp) while X-Over moved materially higher at 247.2bp (+13.5bp).
That X-Over weakness suggests that the high yield cash market might see some considerable pressure in the coming sessions, but we’re not necessarily thinking that’s going to be the case. It could be – and usually is, that fast money is plugging into the weaker market sentiment looking to push X-Over wider and real money is busy hedging cash exposures.
In cash, the corporate bond market though has ended the month resilient from a spread perspective. In the last week of June, for example, HY spreads tightened by 16bp and 27bp for the month as measured by the iBoxx index. And we had €8bn of issuance in June which had no impact on (widening) spreads. All that suggests that this market is in good shape at the moment. In the investment grade sector, it is a similar story, with spreads 3.5bp tighter on an index basis last week and a very encouraging 8bp tighter in the month, the iBoxx index left at B+111.4bp.
iBoxx index yields have backed up though from a year low for IG to 1.21% (+16bp) in the last week, while for shorter-duration HY index they jumped 11bp off a year low to end at 2.88%. That has eaten into returns.
June’s performance battered
The savage back-up in rates has undermined performance in fixed income making June’s total return numbers look bad. It was an almost devastating last week of the month in that respect. IG lost 0.5% in June, and HY managed to gain 0.2% (shorter duration and excellent spread performance). The back-up in rates in sterling made up a 1.15% loss in sterling corporates for the month while euro non-financials lost 0.7%.
Still, for the year to date, we’re in the black. For the first six months of the year investment grade returns are at +0.45% with financials up +1.3% helped in no small part by CoCo valuations (spreads tighter by 41bp in June). Sterling returns have fallen to +2.7% in the first six months (they were over 4% at end May), while only the HY market has held resolute, returning 3.8% in the year to end June. Euro sovereigns are down 1.15% in the period to June having lost 0.55% in the month.
In equities, the US stock market is still flying. The S&P is up 8.4% this year and the Dow 8%. They’re followed by the DAX which is showing returns of +7.4% and the €Stoxx50 of 4.6%. The FTSE has been volatile and dropped back to deliver returns of +2.4%.
Issuance perks up before summer break
Issuance levels in June for IG non-financials were a lot better than we might have expected following on from that very good level of supply in May. June delivered €34.5bn of IG issuance against €34.7bn in May to become the third best month for deals this year which has now totalled some €162.6bn in the year to date. We’re set for a run rate which ought to see us past €250bn for the full year and quite possibly closer to €270bn, seasonality trends included. The main sticking point might be how markets react to the outlook for macro and rates and any volatility which might come on the back of it.
In the high yield market, we had a very good month of deals with over €8bn printed versus €3.3bn in May, leaving us at €34bn for the first six months of the year. That has us thinking in terms of a €60bn record context for euro-denominated non-financial high yield supply for this year. There are enough deals stacked up in the pipeline ready for launch and to some extent this market is immune to moderately rising underlying yields. The demand suggests that to be the case as does the resilience thus far in secondary valuations. Improving macro is a massive fundamental support, too (includes a lowering/lower default rate).
As for senior bank issuance, the €20bn issued in May was nowhere near being repeated and we had just a handful of deals (green bonds and senior non-preferrers, mainly) delivering just €7bn of issuance. We’re up at €90bn year to date but improving credit metrics in the banking sector and steepening yield curves promoting higher profits will keep investors engaged in the asset class with a high level of receptivity for any new offerings. We must be thinking that €200bn of issuance isn’t impossible for the year as a whole.
MiFID II Countdown
A peek at the second half…
The first half of 2017 has all been about lifting as much yield as is reasonable. That is, buy the highest yielding product that the portfolio can withstand and run with it. Ignore the gyrations in the rate markets, buy into any dip and run a portfolio positioning comfortably greater than 1.0. Few would have thought that the spread markets would have delivered as they have, with performance for total return investors sullied only because the underlying through last week came under some severe pressure.
As measured by the Markit iBoxx HY index, June’s 29bp of tightening and the year-to-date cash index tightening of 121bp has been fantastic. As if to demonstrate the risk orientation of the market – and even after a couple of wobblies, the CoCo index has also shown that higher yielding positioning has been the key driver for credit in H1. The index tightened 41bp in June but is 120bp tighter so far in 2017. More of the same in H2 would be most welcomed, but it won’t happen.
Instead, we are looking for a fairly uneventful summer for spread product and only a moderate tightening int he September to December period. IG is 23bp tighter YTD and sterling credit just 4.5bp.
We would therefore think that another 30bp of tightening at best in HY cash, 10bp in IG and 5bp or so in the more volatile sterling markets would seem reasonable expectations over the second half of the year.
For the latest on corporate bonds from financial news sources, click here.