20th May 2018

Italy to the fore

iTraxx Main

58.1bp, +1.6bp

iTraxx X-Over

277bp, +4.3bp

🇩🇪 10 Yr Bund

0.57%, -7bp

iBoxx Corp IG

B+110.75bp, +2bp

iBoxx Corp HY

B+335bp, +9bp

🇺🇸 10 Yr US T-Bond

3.06%, -5bp

🇬🇧 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=”15″], [wp_live_scraper id=”16″]

They just got it wrong…

Investors often have a gripe about syndicate desks tightening pricing too much and then dishing our poor allocations. The reality is, the method (game) of pricing and then building a materially oversubscribed book gives comfort to investors through knowing there is safety in the numbers. All the more reason to look at last week’s pulling of the Bertelsmann deal following the syndicate desk going out with ‘final terms’. We don’t buy for one moment the reason for not proceeding being about waiting for more ‘stable market conditions’.

Admittedly, there is the ongoing US/North Korean tiff and we have some growing nerves around the rising oil price on the back of the US/Iran tensions. We will even throw in the uncertainty as to how the next Italian government might work out, which has led to rising BTP yields, weaker Italian bank stocks and further jitters in Italian stock markets (-1.6% Friday). But in reality, market conditions for new primary market activity is just about as good as we might expect.

We would infer that looking for more stable market conditions meant that they would be back when investors are more ‘desperate’ for a deal, and will fund whatever comes. Bertelsmann got caught out as they tried to price a rich deal (after some bad corporate news) after a flurry of heavier than normal activity. And investors, spoiled by the feast of deals printed, pushed back.

The other point is that we are in a pricing regime where looking at how NIPs stand up against secondary levels isn’t the exact science we had been used to. It works for many frequent borrowers, where liquidity isn’t at a premium, but for the more infrequent issuers (like Bertelsmann) – however well-known, there is an element of price discovery. For this deal, they just got the pricing wrong (the syndicate desk and the borrower).

Italy front and centre

Brexit has been pushed to one side with the Eurozone/EU now needing to sharpen their attention to the unfolding situation on the Italian political scene. The markets have reacted. Italian equities have been underperforming while the bond market is heading for ‘rout’ territory.

The yield on the 10-year BTP rose to 2.23% but higher by 12bp on Friday and 36bp higher in the week (+50bp in last month).

It’s a populist programme that the Five Star Movement/League populist coalition have cobbled together – €780 basic income for poor families, repeal on pension reforms, corporation and personal tax cuts, a withdrawal of EU sanctions imposed on Moscow and a speedy deportation of illegal immigrants (thought to number 500,000). The one relief (small mercies) for the markets was that they dropped the previously leaked proposal for €250bn of debt forgiveness. Had they not, the Italian markets would have been routed across the board. Mind, the budget deficit looks set to spiral out of control as the policies will add a few percentage points to it (already at 2.3% GDP in 2017). Ouch!

The UK was ‘only’ in the EU, but with Italy in the Eurozone, the headache for the ECB and the Brussels elite could be – rather will, potentially be greater. They’re already grappling with a rising tide of dissenting voices and Eurosceptiscm from the likes of Poland and Hungary, but given Italy’s debt metrics it is another ball game. Taking back control? You bet!

Back to safety, but credit weakens…

There was a crunch lower in safe haven yields, as investors scurried for risk free paper ahead of what could have been a difficult weekend (as participants assessed further the ramifications of the new Italian regime). Bund yields dropped again, the 10-year closing the week at 0.57% (-7bp) and in the US, the Treasury yield fell back to 3.06%.

Equities didn’t really do too much in the session, save for underperforming Italian stocks, which lost 1.5% in Friday’s session. The rest had markets off by up to 0.5%.

In credit, we had just Premier Foods in sterling high yield, the £300m long 5NC2 senior secured deal printing with a 6.25% coupon. There was nothing else.

We had much weakness in secondary though. And it came without any material or significant altercation in other markets. That is, in cash, the iBoxx index closed at B+110.75bp (+2bp) which was 4.5bp wider in the week, and the highest level since September 2017. It was not because there has been a lot of supply of late, because the big picture is actually supportive from both a technical and fundamental dynamic. And it’s the same in the high yield market where the index closed at B+335bp which was a 9bp move wider in the session (and week) and is the highest levels since May 2017.

The iBoxx IG index is 14bp wider year to date. No one is panicking, though. IG non-financial issuance at just €90bn is running at over 30% lower so far this year versus last. The market can easily absorb more without there being a need to sell/unwind any risk to make room for it. That is usually the largest technical driver for wider spreads in secondary. The defensive feel in the market last week would have been on the back of Italian politics with perhaps some jitters on the North Korea/US tiff, but we would likely have felt that elsewhere before credit. The lack of activity and illiquidity in secondary markets is therefore exacerbating the defensive marks, in our view.

In high yield, we have had €37bn worth of deals this year, which is already almost 50% of last year’s 12-month total. One could argue here – based on technicals alone of supply/demand – that we have our explanation for wider spreads. We are inclined to disagree because the weakness in spreads has rarely emerged when we have deals in primary. We again believe secondary market inactivity and illiquidity is exacerbating the spread weakness we are seeing.

As for this week, we are anticipating a quieter one on the data front although there will be a particular focus in the Fed minutes to be released on Wednesday. We have another round of Brexit talks as well (Tuesday), although we expect more of a focus on Italy as the market awaits President Mattarella’s blessing to the coalition’s programme as well to a new prime minister (expected on Monday). Primary credit is likely to start off in tentative mood as a result allied with some nervousness which might still be felt on Bertelsmann’s pulled deal.

To end on a positive note, it looks as if the US and China have pulled back from a damaging trade war, putting it ‘on hold’ as China promises to increase its purchases of American goods (farm exports and energy), amid ongoing talks through the summer months.

Have a good day.

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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.