31st March 2019

(Free content) Investors thankful for Q1 riches

iTraxx Main

65.1bp, -3.5bp

iTraxx X-Over

268.9bp, -11.7bp

🇩🇪 10 Yr Bund

-0.07%, unchanged

iBoxx Corp IG

B+139.7bp, -1bp

iBoxx Corp HY

B+439.3bp, -5bp

🇺🇸 10 Yr US T-Bond

2.41%, +2bp

🇬🇧 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″]

Not for long though, methinks…

Few would disagree that it has been an excellent quarter for the fixed income markets, and all being told, an excellent one for equity markets, too. The rising risk of recession – in some quarters they’re thinking depression, as the central banks’ arsenal of firepower draws something akin to the proverbial blank when it will be called into action – is going to change the landscape for asset markets later this year. That impotency is going to make the next downturn much worse than the last. Just as well we have bagged some solid performance because some markets will start to give some of that back through the next nine months. The Dax is still up 9%, a Brexit-maligned FTSE up 8.3% and the S&P some 13% (!), while euro-denominated IG credit investors bask on returns exceeding 3% and high yield portfolios are bolstered with 5%+ gains, all for Q1 2019. But something’s not quite right when rate markets return 2.6% (Eurozone) in the same period.

Behind all that lies an altogether different story. We’re heading into a recession (we think we are already effectively in one). The central banks (ECB especially) will be behind the curve. Adjusting rates to help bank profitability is a tacit recognition of the failure of their policies – and of angst to come. More QE, we would think, is just around the corner. The US/China spat is going to rumble and Trump will be emboldened by the outcome of the Mueller enquiry and will surely seek a second term in office. He will keep playing hardball.

Global trade weakness begets a global slowdown in macro overall, and inflation targets are going to prove unattainable. Much is being written again about the different forms of QE that might need to be executed (helicopter money and the like) such is the growing fear that something bad is going to happen.

So we have flight to quality/safe-havens. And without the previous hoovering up of assets through central bank QE, we’re printing 10-year Bund yields at close on the previous record low of -0.13%. Brexit is the main culprit in the UK, but Gilts yields are only dropping just below 1.00% recognising that if the Eurozone endures economic disaster, the UK won’t be spared.

In the US, Treasury yields are plummeting, there’s inversion in the 3-month/ 10-year curve which is usually a predictor of a recession to come. And the economic data just about across the board is corroborating evidence enough. The fall-out might not be as immediate nor dramatic as some might think. The central banks are sitting idly by, but the path of least resistance in macro is clear.

In credit, many peripheral banks are busted, for example, but they will limp along as the ECB extends the ‘jug of liquidity’. Prolonged economic weakness ought to crush a highly and over indebted high yield corporate sector, but lower rates and investors crowded out again from IG markets (if we get corporate QE again) will keep their debt obligations rolling over.

So look for equity volatility, lower rates and the Bund yield in the 10-year to snuggle up to -0.2% in due course, EM credit and FX to get its comeuppance after years of avoiding catastrophe the regions’ debt binge managing to stave off, while we are going to have to expect a European corporate default rate to break out of the 3% level it avoided in the pst decade – but be contained as funding costs drop hard and refinancing abilities are sustained.

Q1: Primary flourishes

The second best month for issuance since September last year in IG non-financial corporate bond issuance, March came up trumps with €30.7bn. The opening quarter of the year was also the best rolling 3-month period for issuance in this sector of the market since early 2016 (Feb-Apr). For sure, the theme has been multi-tranche deals with eleven borrowers choosing to print 2, 3, or 6-tranche transactions. The latter was Medtronic’s €7bn haul at the very beginning of March.

We’re up at €84.5bn for the quarter and that is well in excess of our – and most others’ – expectations. At this rate, we’re heading for somewhere in the region of €250bn for the full-year, accounting for the usual drop in issuance levels in the summer and other ‘seasonal’ periods. That would bust our early year forecast for around €200bn (versus actual issuance of €220bn in 2018).

Whether we get there is going to depend on how much borrowers are licking their lips at the current dramatic drop in funding costs. There’s an argument that they might choose to wait until the ECB is called into action again, but there is the usual balancing act between further macro weakness/market volatility which might close primary in periods versus getting some cheap cash on the balance sheet now, while the going is good.

The poorer level of deal flow, seen pretty much since the end of the first quarter, has continued into 2019 for the high yield market. It’s not great. We’ve had €10.5bn of issuance with March’s €4.8bn the best month for deals since September last year. There has been some concern around economic weakness and all that holds for the high yield market in terms of performance and default rates and the like.

The key takeaway from the last decade has been that low funding rates and investor demand (forced or otherwise) has managed to help borrowers roll over maturing obligations, removed the immediate worries about potential walls of funding and kept the sector ticking over. The bar for all of these variables has risen, we would think, but returns of around 5% in the opening quarter will have helped confidence.

For the full-year, we are looking in terms of €40bn tops for issuance though which would be well-down on the range we have seen in the 2014-2018 period (€48bn – €75bn).

The senior financials sector has had a good quarter – as it usually does, but at €43bn of issuance, we’re looking at around the €130bn level for the full year. Again, that is way in excess of our earlier expectations, but activity has been very good in this opening period with €17.5bn issued in January, €15bn in February and a touch over €10bn in March.

Q1: Performance aplenty for all

Fixed and equity markets were vying for the best relative performer through the quarter. They’ve both had a quite brilliant one, all being told. The FTSE – at the mercy of the Brexit debate and effectively three meaningful votes (all failed) – managed to rise by 8.3% anyway.

A slowing Germany with manufacturing there and across the Eurozone essentially in recession – or will be confirmed to be that way soon enough, saw the Dax still manage to gain 9%, with the €Stoxx50 up 12.7% in the first quarter. That’s all excellent, but in the US, the S&P put on 13.1% and the Dow 11.1%.

In credit, it has been a superb quarter. Spreads are tighter across the board and total returns at very high levels, of course all boosted by the rally in the underlying government bond market. IG credit has returned 3.25% split equally between financials and non-financials in Q1. In March, the IG index returned 0.5% (versus +0.7% in February). IG spreads (iBoxx) tightened by just 5bp in March but still by a huge 32bp in the first quarter.

The high yield market, supposedly under pressure as the macroeconomic outlook worsens, has returned a stunning 5.1%, helped by lower yields everywhere else and lower financing costs to come for borrowers when they finally (if they finally) decide to pull the trigger on deals. The high yield iBoxx cash index was 9bp tighter in the month and 84bp tighter in the first quarter.

Even sterling corporate markets are feeling no pressure from the Brexit situation, the rally in Gilts and spreads seeing returns top out at 4.8% for the first quarter. Top of the pile though is the AT1 market, with spreads 110bp tighter in the opening quarter (+28bp in March though) and returns for the first three months of the year at 5.2%.

With all that, we closed the final session on the front foot with a risk-on session, despite the shenanigans at Westminster. IG credit spreads as measured by the iBoxx index closed almost a basis point tighter at B+139.7bp, with the high yield index left at B+439.3bp (-5bp). There were no deals in the session. The iTraxx Main contract closed strongly at 65.1bp (-3.5bp) as did the X-Over index at 268.9bp (-11.7bp).

It will be too much to expect that we can tighten another 30-40bp – even in the rest of this year (unless QE goes nuclear), or that returns can add another 3% (unless goes nuclear). We would think that the big moves in corporate credit have probably been made already for this year. Portfolio positioning bias should stay towards higher beta risk. For Q2 though, money will continue to flow into the asset class as it chases that Q1 performance in an ‘I’ll have some of that’-like expectation, and this might help to support the market versus other asset classes, from a relative perspective. 

For this week, there will be more – much more – on Brexit and UK politics to contend with, and right from the start with those indicative votes on alternative plans to be held on Monday. The US/Sino trade talks continue and we wrap up on Friday with March’s non-farm payrolls report with consensus estimates pitched at around 170k.

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.