13th March 2017

The hangover is coming

FTSE 100
7,343, +28
11.963, -15
S&P 500
2,373, +8
iTraxx Main
71.8bp, +0.4bp
iTraxx X-Over Index
283bp, -0.7bp
10 Yr Bund
0.48%, +6bp
iBoxx Corp IG
B+131.3bp, -1.3bp 
iBoxx Corp HY Index
B+364.3bp, -4.5bp
10 Yr US T-Bond
2.58%, -2bp

Caught in a trap

Fixed income markets have partied hard for the best part of seven years. And now the hangover is about to come. We’re at that point where the markets are all a tizzy about the prospect of multiple rate moves in the US – and then some more on reports into the close last week that the ECB had discussed tightening policy before QE ends.

We saw the inevitable reaction – 10-year Bund yields to their highest levels this year at 0.48% (+6bp). We should, though, allow the markets to settle after the likely Fed move this week, then start to think a little more carefully about investment strategies and how they might need to change. After less than three months of positioning for how 2017 might evolve, it could be that we are needing to go back to the drawing board. Q2 in that sense is going to be very interesting. Few will change tactics right at this moment.

In the US, three hikes or four – does it really matter? They’re coming after that excellent non-farm payroll report that saw 235,000 jobs added in February, and year-on-year wage growth rising to 2.8%, from 2.6% previously. The US looks like it is going great guns and the Fed has all in its favour to raise this week. More of this type of upbeat economic data and there will be three more rate increases to come in 2017. The trap? Can Janet Yellen steer the markets to believing that she is the curve – and whether it is two or three more moves – that the Fed will call it right?

If they get it wrong, then we’re heading for an almighty thud as the economic juggernaut in the US will prove hard to turn around again, EM risk will feel intense pressure (higher rates, huge debt burdens) and any faltering in global growth on the follow could tip us into another financial crisis. It’s not as if a debt burdened global market has elicited a more responsible consumer/corporate dynamic, punch drunk on accommodative monetary policy for as long as many can remember. That accommodation has allowed us all to service our debt with little difficulty – but not reduce it. Gently stepping on the brakes in the US is necessary, but it’s how the rest cope with it which will determine whether we’re busted or gushing come 2018.

The reaction to the payrolls data on Friday – and using that session alone as a harbinger of what the markets might think (as unreal as that is), suggests that the Fed will get it right. Equities up, government bonds under a little pressure, credit spreads stable to edging better for choice for now – but fixed income returns in the red. It’s shaping up to be a tough old year for fixed income, while in credit, investors will be paying away what little performance they have if they decide to hedge out any rate risk.

Credit holds firm – for now

An improving economy should always be helpful for corporate bond market fundamentals and classically for valuations. That’s how it played out last week with the market finally getting a bit of a boost even as total returns for the asset class decline. As measured by the Markit iBoxx index, IG spreads ended the week 2bp tighter (-1.3bp on Friday) at B+131.3bp and we’re 3bp tighter for the year so far, leaving all the spread performance to have come this month. Returns, though, have been pressured by the Bund market sell-off and have dropped to -0.5% YTD.

There are still three weeks to go before the end of the month, and event-risk might just see a return of the safe-haven bid which sees us back into positive territory for the quarter, but it’s not the sort of situation we should hope for to help performance.

As for sterling, spreads closed out on the index marginally tighter at G+148.6bp and for the week that was unchanged. Returns are just in the black YTD for this very long duration market, but Gilts have been relatively stable as the sterling market grapples with its own issues around the UK economy which seems completely disconnected with what’s happening elsewhere.

The high yield market is where the performance is, however. Defaults reside at historically low levels – one has to be very unfortunate to hold anything which doesn’t pay up at the moment, in a reasonable portfolio – and this market is showing tremendous resilience. While, in the US, the declining oil price is affecting valuations in the market there, we’re generally on a tightening trend here. The HY cash index closed the 4bp wider, but that’s still 49bp tighter in the YTD which will keep benchmark investors happy enough. Returns are also in the black for this shorter duration market, at 1% YTD – admittedly though off the best levels we have seen this year.

Even the indices are “behaving”, although they ought to be react positively to improving macro. iTraxx Main is at 71.8bp (+0.4bp) and X-Over at 283bp (-0.7bp).

Primary delivering

The new issue market has had a decent start to the month. IG issuance has delivered €9.25bn of deals this month, with €6bn of that last week from non-financial corporates. We’re still targeting somewhere around €30bn for the month, with borrowers likely hoping to get deals in before we get any French election-related volatility come April and the first round of votes there. This week we have the Dutch election and FOMC so we could potentially see a busy start to the week and a few deals at the back end of it.

The high yield market has similarly been fairly effusive with €3,307m for the month so far and we could expect to more than double that total before the month is out given the size of the pipeline.

Next week is all about the Fed and we should keep a close eye on those Dutch elections – both on Wednesday. An upset is on the cards with the right-wing populist Wilders’ party looking to cause what would be a serious upset, if they succeed. The Fed will raise rates by 25bp.

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.