26th November 2017

It’s a funny old game

iTraxx Main


iTraxx X-Over


10 Yr Bund

0.36%, -1bp

iBoxx Corp IG

B+99.5bp, -0.5bp

iBoxx Corp HY

B+279bp, -1.7bp

10 Yr US T-Bond

2.34%, +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″]

Keeping an eye on 2018…

We have a week to go before we end the month, and just 6 weeks before year-end but we think that activity will likely halt come the third week of December. In credit, some are already wondering how the asset class is going to make money in 2018. Much, if not everything is going to depend on duration markets, because higher rates – which are most likely even if we all called it wrong in 2017 – are going to eat into returns.

The vast majority of the inflows into the corporate bond market since the crisis have been into total return funds. Capital preservation and a bit of income have been the reasons for it. That money could be looking for a bolder investment in 2018 – if the prevailing view is that sustainable growth is back, the rate hikes are going to be limited so that we give that growth chance and time to become entrenched, meaning we head for equities as the asset class for choice. With that in mind, as well as the current record spread levels, any material credit spread upside looks difficult to achieve.

For the next few weeks, we’re protecting returns of 2.6% year to date in IG, an even better 6.3% in high yield, while the contingent convertible bond market has delivered 17%. That’s all index-based and we are quite sure that investors have exceeded all those levels. Benchmark investors have also had a whale of a time. Spreads are off their record tights for the higher beta areas of the market, but the CoCo sector has tightened by a whopping 280bp this year, the iBoxx high yield index by 130bp and the IG index by 34bp. Again, with most investors running a beta in excess of 1.0, there performances will have been much better.

There have been few accidents, too. The default rate is low while the couple of borrowers which defaulted in the CoCo market failed to promote any contagion into the broader CoCo sector – or anywhere else for that matter, as investors took a pragmatic view on those well-flagged events. But also, when needs must, then there is always a justification not to panic – not to reduce risk and hope. The need for excess market liquidity to find higher yielding assets has trumped all potential banana skins.

Much is being made of the outflows from high yield funds at the moment – especially in the US, but in Europe spreads are recovering form the early November weakness. While cash flows into IG funds, it should not be lost on anyone that those IG funds can usually hold up to 20% of high yield debt. So some of those inflows will find their way to lifting high yield bonds. That is, we don’t think high yield spreads are going wider unless there is a significant equity market sell-off leading to some contagion impact given the close correlation between equities and high yield valuations. Stay with it.

Positive but reflective tone

With that in mind, the high yield market continued to squeeze – helped by another record-breaking session in US equities, while the VIX volatility index hit a record intraday low of 8.56% before closing at 9.67%. The Black Friday sales reports will be out soon enough and if they’re upbeat (which is likely), then there is going to be every reason for a positive end to the month for US equities. That will ensure we recover some more of the earlier month’s lost performance in credit spreads. The S&P closed above 2,600 for the first time as the Nasdaq also closed at a record high.

While equities were rising, rate markets were doing very little and yields moved up or down a basis point or two at most. Gilts closed out yielding 1.25% (-1bp), US Treasuries 2.34% (+2bp) and Bunds at 0.36% (-1bp) – all in the 10-year benchmark. The US 2s/30s was unchanged at 0.98% as the yield curve debate rages. With a rate hike likely to come in December pressuring the front end, but the absence of any significant inflation anchoring the long end – and with Treasury preference to finance its funding needs through more short term debt – there is much to ponder. For sure, corporate funding is likely going to see the sale of longer dated debt, in the US.

Credit, slowly but surely

In credit, the rising equity markets gave a quiet market enough of a reason for the Street (anyway) to mark spreads tighter. There was no significant supply with investors consoling themselves with just a €250m tap from Redexis Gas of its 2027s while int he high yield market we had Raffinerie Heide take €250m in a 5NC2 structure priced to yield 6.375% – and it was the week’s only HY print.

As a recap, the IG non-financial issuance total for the month is now at €27bn and the year to date total stands at €255bn. We’re not sure what this week might bring, but there’s much reason to believe that it could be decent with borrowers probably looking to get some final bits of funding in especially into positive markets before we close out for business in effectively 3 weeks’ time.

As for high yield, just that single borrower printing last week meant that we are up at €5bn for the month (which is excellent) and €67bn for the year which is a record. There is still plenty of demand for high yield risk despite the increasing stuff being written about the market being on its last legs – in the current cycle.

The Markit iBoxx IG cash index closed at B+99.5bp (-0.5bp) and is just 5bp off achieving that record tight. We got to within a basis point of it a couple of weeks ago, but will need a good solid push to get close again. The high yield index also squeezed a little, edging almost 2bp tighter to B+279bp, with 25bp to go to also see those record lows of early November. iTraxx Main closed at 49.1bp and X-Over at 235.8bp, both making smart recoveries and outperforming cash this month.

As for this week, the interest is very US-focused. We have the Beige Book outlook on the US economy, the new Fed chair’s confirmation hearing (replacement for Yellen when she steps down in Q1/2018), and then inflation, US GDP and manufacturing data. There’s also a potential Senate vote on Trump’s tax reform. The latest BoE banking stress test results are also out, and might hold some interest.

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.