10th October 2018

Inflation concerns trump Italian ones

iTraxx Main

71.8bp, +0.7bp

iTraxx X-Over

290.4bp, +3.8bp

🇩🇪 10 Yr Bund

0.55%, +1bp

iBoxx Corp IG

B+131.5bp, unchanged

iBoxx Corp HY

B+392.3bp, unchanged

🇺🇸 10 Yr US T-Bond

3.22%, +1bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”18″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”20″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”22″]

Complacent? Not on inflation…

Will something just happen! – because so much has threatened the end of the run that financial markets have had in the decade since the crisis started, but we’ve managed to see off most situations. Italy threatens now but it isn’t erupting – and until it does the contagion from the shuffling that we’re seeing now between the government and the EU Commission could be contained. The same goes for Turkey, the sovereign’s woes no longer make front page news and therefore we don’t need to think about them. EM event risk generally seems to be a slow-burning fuse but as long as nothing blows up and causes widespread contagion, the markets are going to feel complacent about the risks.

Maybe all the liquidity in the financial markets (it is still cheap) has managed to quell many of the risks and while absolute debt levels continue to rise – inexorably – the burden is less worrisome than we think because the ability to service the obligations is still so good. In that sense, the US rate increases are a shot across the bows at the moment, but we might be looking at the markets in a whole new light sometime in 2019.

That’s all for another day. Right now, the markets are reacting to certain events as they make the headlines. The defensive tone lasts for so long as that is the case, then we start to see stability and an inevitable recovery. That recovery in asset prices seems to have been more measured across European assets versus one which has been far more gung-ho in the US. The macroeconomic risks are different, after all.

Anyway, we’re almost at the midpoint of October and the month has disappointed. The DAX is edging closer to being 4% lower for the month, while the S&P index is down by over 2% in October – after having seen a record high earlier in the month. Rates have been the culprit. We had the expected rate increase in the US, the data has been good and the Fed is on course for another hike in December with several to follow through 2019. The large recoil in yields (higher) in such a short space of time has equity market looking scared – and rich, in valuation terms versus rates.

In European credit, one could argue that we are lagging. Underlying yields have moved higher, but not to the same extent as in the US. Credit spreads generally are holding firm, helped by barely any levels of primary activity (this month), continued relatively decent purchases by the ECB and enough sidelined cash with nowhere to go to leave investors holding on to their positions (despite escalating Italian event risk).  Few will sell now because it will be expensive to rebuild positions.

Drab primary

The deals in primary were few. CPI Property Group SA issued €600m in a 3.5 year maturity at midswaps+145 and off a €1.7bn book still managed to ram pricing tighter by 25bp versus initial guidance. The other deal in the corporate sector came from Luminor Bank which took €300m in a 3-year at the initial price talk of midswaps+150bp.

Green bond for Ireland

The big deal of note was Ireland’s 12-year, €3bn green bond offering at midswaps+12bp (-3bp versus IPT) which saw demand for around €12bn.

The deal count makes for poor reading. In IG non-financials, we have had just 8 issues (6 borrowers), while in senior financials it’s €1.35bn from three issues and two borrowers. As for high yield, it’s €780m from two issuers – and that record supply for the full year that we had had our eyes on looks unachievable this year.

Yuck (equities), yuck (blame it on rates), hmm (credit)

And so it was another difficult session. Actually, it was an extremely poor one. A slow start with the market on the defensive turned into something of a rout as the US tanked. US retail giant (and much troubled) Sears group was battered as it looked like bankruptcy proceedings were nigh. That was followed up by some solid producer price data for September which saw a solid pick up of 0.2% month on month in PPI, which was in line with expectations.

At the time of writing, the S&P and Dow were off by 2.2% and the Nasdaq by 2.9%. European stocks took a leg lower as the US opened, leaving the DAX off at 2.2% at the close and the FTSE 1.3% lower. The DAX is now down by 9.4% this year an the FTSE by 7%.

Rates were also under a little pressure and yields rose but only a touch more. The 10-year Gilt yield was up at 1.73% (+1.5bp), the Bund closed at a yield of 0.55% (+1bp) and the US Treasury was yielding 3.22% (+1bp) at the time of writing. Devoid of any headline risk, Italian debt was a tad better in the session with the 10-year BTP yield eventually just a basis point lower at 3.52%.

Even though it was quiet from a specifically named event risk situation, there was no way the credit indices were going to behave any differently other than move in the same direction as equities – that’s wider for them. The cost of protection rose but in extremely measured form, leaving iTraxx Main at 71.8bp (+0.7bp) and X-Over at 290.4bp (+3.8bp).

In cash, it was quiet in terms of flows and volumes and while we had a defensive Street bid, nothing too much happened. Cash outperformed synthetics. We managed to close unchanged, perhaps as credit exhibits its defensive qualities. Even the CoCo market was a touch better! That all left the IG iBoxx cash corporate index at B+131.5bp. The sterling market was better bid.

And finally, in high yield, we drew another bank in primary and that weak equity performance failed to elicit any pressure on secondary. The close correlation between the two markets broke down. The index was finally left at B+392.3bp – unchanged.

With that dire overnight performance in the US, we can assume that Thursday’s session will be a light one.

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.