2nd March 2019

Goldilocks? She never left us

iTraxx Main

62.5bp, +1.3bp

iTraxx X-Over

279.7bp, +3.7bp

🇩🇪 10 Yr Bund

0.19%, +1bp

iBoxx Corp IG

B+145bp, unchanged

iBoxx Corp HY

B+444bp, -4bp

🇺🇸 10 Yr US T-Bond

2.76%, +3bp

🇬🇧 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″]

Needles and haystacks…

The markets want to rally. The opening session of the month greeted us with equities shooting higher courtesy of weighting changes which gave Chinese stocks a greater share of the MSCI emerging market index. That gave a boost to global stocks from the start, although better-than-expected retail sales gains in Germany in January were seen as another reason for hope on macro. Also, weaker US data later supported the view that rates won’t be going higher anytime soon.

The good news in that was enough to get March off to a flying start and sustain the momentum of the previous two months which had seen some excellent performance being recorded across all asset classes. No fear, then. We could be lining up for a good March and solid opening quarter.

On the flip side, however, youth unemployment in Italy rose to more than that in Spain (to a massive 33%) suggesting that the fuse is burning a little faster for the Italian economy/politics, while both Italian and Spanish manufacturing activity slipped to their lowest levels in five years according to the latest PMIs. Core inflation dropped to 1% in February from 1.1% across the Eurozone.

In addition, we had some weaker than expected data from the US on personal spending (-0.5% MoM in December) and income (-0.1% in January versus -0.3% in December). The Fed’s favoured measure of inflation measured through the PCE was unchanged at 1.9%.  Overall, the macro outlook is showing no let-up in its deterioration and this must be reflected – soon – in both policy and market levels.

In the corporate bond market, it’s about hoping for no cliff risk event – and to add as much higher beta risk as is reasonable and allowable portfolio limits given that the default/rating transmission and interest rates are supportive.

Superb performance YTD

In February, IG credit returned 0.7% – taking total returns (iBoxx index) for the year to end February to 1.8%. In that, credit spreads in IG have tightened by a massive 27.5bp to B+145bp roughly split evenly between January and February. Financials have slightly outperformed non-financials.

The mood has been good, primary has been taken down extremely well, and the confidence has been reflected throughout the market even as recession risks loom. The sterling corporate market hasn’t been left behind, index spreads tightening by 22bp and total returns in the period to end February exceeding those in IG euro-denominated credit, at 2.2%.

Higher beta risk has benefitted from the expectations that the Fed will remain patient on rates and that the ECB might be called into action soon, rather than continue with its tightening policy. Macro is in a prolonged slowdown and it’s only time before we call a technical recession across the Eurozone. That leaves us better bid for higher-yielding risk and even the non-call of the Santander AT1 issue failed to dim the lure of CoCo risk. This index returned 1.4% in February (spreads -40bp) and has returned 4.9% in the year to end February. Spreads have tightened by 140bp to B+570bp in the first two months.

The high yield market has followed. The sector hasn’t exactly been flush with deals, with just €5.6bn issued from 9 deals, but has returned 1.9% in February and some 4.2% in the opening two months of the year. Again, an excellent performance given the perceived macro slowdown risks there might be against higher-yielding borrowers.

Of course, corporate bond market total returns have been helped along by the solid bid we have seen in this opening period for government debt. The underlying (Eurozone index) has returned 0.75% in 2019 to end February.

The excellent bid for corporate b0nds has been made possible because equities have also been rising almost uncontrollably, it would seem. The S&P and Dow have added circa 11%, while a recession-prone Germany hasn’t put off German equities where the Dax has risen by 9% this year. The broader €Stoxx50 is up 0ver 10%. Lagging has been the FTSE, up just 5.1% in the two months to end February.

Primary making the most of it

The corporate debt primary markets are making hay while the sun shines. The good bid for risk assets has allowed borrowers to jump in and get some high levels of funding in. A key feature has been the reduced concession to get a deal away given the demand for transactions where the books have been subscribed anywhere between 3 – 6x. And usually at the upper end of that range.

After opening with a €26.94bn load in January, the IG financial sector followed with pretty much the same figure (€26.9bn) in February. That took the total issued to €53.84bn for the opening two months and that is already the best opening start to any year since 2015. Last year failed to see €30bn issued in the opening two months and Q1 218 only delivered €55bn of issuance.

We had forecast a reduced amount of issuance this year, to somewhere in the region of €200bn which would be the lowest level of supply in over a decade – if proved correct. However, we are way out of the market as it stands and should we maintain the current momentum – then upwards of €250bn will be possible. How the months of March and April play out will go some way in determining the potential for a high total.

The high yield market has disappointed. There has been some apprehension about the recession risk looking in the Eurozone and how that might impact the category of borrower, but low rates and demand for higher-yielding risk ought to keep the sector supported. So far, just €5.65bn of debt has been issued and that has come from 9 borrowers. We could expect that deal flow to pick-up should the demand we are seeing in IG hold up, and as investors become more confident again about adding high yield debt. We’re still on target for no more than €45bn for the full year.

Senior bank issuance in the opening two months of 2019 is running at around the same level as in the corresponding period in 2018, with €32.6bn of issuance. €15.1bn if that has come in February and is a higher level than in February 2018. The opening quarter is usually the brightest and issuance tends to tail off thereafter. We still expect somewhere in the region of €110bn for the full year (which would be a record low).

Keep on going

We got off to a good start to the month, as mentioned earlier, with US equities higher by up to 0.8%, European bourses adding up to 0.75% amid a generally better tone in the market. There was some defusing of the Indian/Pakistan tensions with the latter releasing the captured pilot as a goodwill gesture while any concerns markets might have had around the US/North Korean summit faded.

Banco BPM issued €750m

Rates edged higher for choice leaving the 10-year bund to yield 0.19% as we closed the week and the 10-year US Treasury around 2.76% (+3bp).

In credit, the only deal in the session came from Banco BPM which issued €750m in a senior 3-year non-preferred at midswaps+205bp. Secondary was quiet and we closed unchanged in IG at B+145bp (iBoxx), better bid for choice across higher beta sectors which left the high yield index at B+444bp (-4bp) – that’s 80bp tighter this year.

There was some reversal in index, iTraxx Main up a touch at 62.5bp (+1.3bp) and X-Over at 279.7bp (+3.7bp).

As for this week, non-farm payrolls closes us out on Friday with expectations pitched for between 170-180k additions (after 304k in January) and a 3.9% unemployment rate. The ECB’s monthly press conference will grip markets on Thursday (expect no changes), but we will be focused on the tone of Draghi’s message for clues as to their next possible move (and the timing of it). We also have final service sector PMIs for February across Europe on Tuesday, along with the Caixin Chinese service sector PMI.

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.