24th January 2018

High yield market underperforming

iTraxx Main

43.8bp, +0.3bp

iTraxx X-Over

231.7bp, +2.9bp

10 Yr Bund

0.59%, +2bp

iBoxx Corp IG

B+85.5bp, -0.7bp

iBoxx Corp HY

B+266.5bp, -3bp

10 Yr US T-Bond

2.64%, +2bp

FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] S&P 500 [wp_live_scraper id=”10″], [wp_live_scraper id=”11″]

There are richer pickings elsewhere…

Why is the high yield market the big laggard in the corporate bond market rally? There just seems to be no traction in spreads which are being marked tighter – but extremely reluctantly. Investor push-back for debt in the sector’s secondary market suggests that they’re all in defensive mode as far as chasing the market is concerned. Carillion and Steinhoff-related event risk are secondary issues and, in our view, not the reason for the lack of performance. New deals are being received very well after all and they’re at the higher-beta end of the HY risk spectrum.

Admittedly, there is some event risk around, and headline risk does impact sentiment. But a European/global default rate residing below 3% suggests some really bad luck if one is caught with a defaulting/defaulted bond in their portfolio. The structural issues around looser covenants are ‘old-hat’ and have been with us for several years – and for now is a non-issue.

However, that’s not to say that there is no bid for high yield rated corporate bond risk – it’s just not in the secondary market. We’ve had over €3bn of issuance in the past week alone and some of the deals have been quite testy. The pipeline is good, too, so borrowers are not going to be shy in coming forward, knowing that demand is there. The secondary market is rich (close to record tights in spread), but secondary market liquidity is about as poor as it has ever been, and few are chasing this area of the market because of that richness in valuations. And there are better options for both IG investors where portfolios hold up to 20% of high yield rated risk, as there are for pure high yield investors. Furthermore, IG investors also have a higher allocation towards financials versus non-financials as macro improves.

The big alternative corporate bond investment is the contingent convertible bond market. Investors have moved on from HY corporate debt and into this market. Banking sector credit quality is stable and improving in some cases as macro turns higher, and this offers comfort to investors buying this deeply subordinated product. Event risk, that is, is reduced markedly.
Multi-asset investors are switching (have been for the best part of a year) from pure high yield corporates to higher yielding CoCo structures. Asset allocators are preferring to add CoCo debt and squeeze the last drop of juice from this market, before they inevitably rotate out and back into equities.

It has left high yield spreads, as measured by the Markit iBoxx index, to have tightened by 20bp YTD or 7% – and by 29% in the past 12 months. However, as if to highlight the huge difference in (ongoing) performance, CoCo spreads have tightened by 70bp this year and by over 50% in the past year! In our view, the HY market hasn’t been the principal focus for investors of late – apart from in primary.

In the CoCo market, primary is lighter and we can expect up to only €30bn of issuance this year (versus €55-60bn in HY). The former is going to continue to outperform in 2018.

Primary’s last flutter, pre-ECB

Innogy SE: €1bn in a July 2029 maturity

There was a little for everyone in the session. We finally had a benchmark deal in IG non-financials – the first in a week, as Innogy SE printed €1bn in a July 2029 maturity at midswaps+50bp, versus an initial guidance level of midswaps+65bp. The book was at €2.4bn. For the month so far, issuance is now up at €16.75bn. We’re unlikely going to see anything on Thursday (ECB day) and Friday might also draw a blank.

In high yield, the sole issuer was Casino, in the form of a €200m tap of the borrower’s €550m 1.865% June 2022 issue. The deal took us to €3.07bn of supply in high yield – all coming in the last week.

There was nothing in senior financials, although Luxembourg-based REIT Aroundtown SA was back (again and again) following up its hybrid transaction earlier this month with a €800m 10-year deal priced at midswaps+95bp (-20bp versus IPT on books at just over €2bn).

The most interesting deal of the day was UBS‘ PNC5 AT1 offering, priced to yield 5% for $2bn and off a $8bn+ order book. The borrower’s coupon was over 2% lower than the similar issue from August 2016, and roughly in line with the market.

Macro good, rates under pressure, IG record again

Elsewhere, UK employment rose to a record high of over 32 million and wage growth held at previous levels. That was the trigger for a sell-off in gilts while stocks in the UK fell after the US was seen to be pursuing a weak dollar policy, given comments emerging from the Davos gathering. So the economic numbers saw to it that gilt yields rose, the 10-year to 1.41% (+5bp) while stronger sterling ($1.42) took the shine off stocks and the FTSE was off 1%. US stocks opened better, but faded the gains to close lower as record closes eluded for a change, even if the S&P500 did hit a fresh intraday record high early on.

Other rate markets also came under pressure with the 10-year US Treasury yielding 2.66% (+4bp) before recovering to 2.64% (+2bp), Bunds were up at a yield of 0.59% (+2bp) and moves higher in the periphery were much more limited. Eurozone PMIs were at pre-crisis highs, French water group Suez’s shares tanked by almost 20% after delivering a profit warning and GE also missed expectations although this was well-flagged.

In the credit market, the iTraxx indices edged wider in line with the weaker sentiment we saw in equities. iTraxx Main was 0.3bp higher at 43.8bp while X-Over rose 2.9bp to 231.7bp.

As for the cash market, we set a new record tight for the IG iBoxx index of B+85.5bp as we squeezed another 0.7bp in the session. This is our year-end target! No such concerns for this market in terms of value – but the ECB is lifting an average of €1.3bn of debt per week. The 11bp of tightening in just three weeks is fairly euphoric for IG credit. In the high yield market, the cash index closed at B+266.5bp (-3bp) and saw to it that cash outperformed synthetics.

The ECB is up next, so expect a very quiet session on Thursday. They’re unlikely to change anything in terms of policy. 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.