11th November 2016

Embracing Keynesian economics

FTSE 100
6,828, -84
10,630, -16
S&P 500
2,168, +5
iTraxx Main
74.5bp, unchanged
iTraxx X-Over Index
335bp, unchanged
10 Yr Bund
0.27%, +7bp
iBoxx Corp IG
B+125bp, -2bp 
iBoxx Corp HY Index
B+417bp, -9bp
10 Yr US T-Bond
2.14%, +9bp

Trying something different…


It should be a quiet day all-round

Let’s take a deep breath, survey the landscape and get on with business. It might not be business as usual, but the world hasn’t suddenly stopped dead in its tracks. We think too much is being put on Trump’s qualifications/abilities – or not, to lead. He fairly won a two-horse race, but the quite hysterical response would have it that the end of civilisation as we know it is nigh. Which, of course, it isn’t.

As far as economic policy is concerned, Trump is potentially in bed with Keynes as the markets anticipate massive expansionary fiscal policy. We’ve tried monetarism – we’ve had eight years of it cutting rates to the bone and into the marrow in some cases (negative rates).

While we’re not arguing economics or the merits of Keynesian economics here – many have promoted the view that governments need to spend heavily to get us out of this eight year slump. We’re about to find out if even that is going to be successful as it does come at a time when most governments (and consumers) are already grappling with high debt burdens.

Monetarism has left us with a huge liquidity trap as politicians have failed to promote confidence in the economic outlook, hamstrung by an inability or unwillingness to enact structural reform in the Eurozone. The latter hasn’t necessarily been missing in the US, but Trump unleashing a spending-fest could see growth break out of the 2%-handle complex. It might give politicians in Europe a nudge in the right direction.

So the markets are now fully anticipating great fiscal expansion. Bond yields in the US are rocketing higher and they’re taking all others with them. There is scant sign of a decoupling at the moment. Trump is becoming the great saviour of the US economy but it will not necessarily help the global environment to the same degree. There is fear and concern – rightly so – about the potential for US import tariffs, as well as what foreign earnings repatriation might mean for investment (more domestic as a condition for lower tax rates?) and how that subsequently manifests itself in terms of the potential hit on global trade. EM is rightly concerned.

At one stage, 10-year Bund yields were up at 0.30% (+10bp) in one of the largest pull-backs in recent memory. Fixed income returns for 2016 are being slashed in an instant – even if corporate bond spreads are rallying. It won’t be enough of a rally to offset the pull back in rate markets. Admittedly, the front-end has failed to move much (ECB policy rates staying low) and this should help the shorter-duration high yield corporate bond market easily outperform versus IG returns.

The higher yielding environment won’t necessarily be offering much consolation to the ECB and politicians across Europe, given that the move is more technical and US-centric, rather than their being any sea change to fiscal policy in the Eurozone.

We’ve suggested in previous commentary about being careful what we wish for.

The rate sell-off gathering steam

The 10-year Bund yield might have been battered, up at an intra-day high of 0.30% (closed at 0.27% +7bp and the 30-year +9bp to 0.91%), but the equivalent maturity BTP was crushed – leaving the yield on it up at 1.89% (+15bp) with the Bono yielding 1.38% (+11bp). This really is the market story post that US election result. Italian yields were down at 1.00% in August, Bonos hit record lows (some 50bp lower than the current yield) and the 10-year Gilt was yielding 0.50% in the summer versus an intra-day high of 1.36% (+10bp, closed yielding 1.34%) in yesterday’s session. For good measure, US Treasuries lost more ground, the 10-year yielding 2.14% (+9bp) and 2s/10s steeping more to 122bp!

We think all bets are off as to where yields could conceivably go. The Eurozone is stuck in a rut and higher yields are going to be extremely unhelpful. The prospect of higher growth in the US might, at best, only help at the margin here – assuming US economic policy is very inward looking. Therefore, the current fear regarding higher yields might materialise as being the US’s bond dynamic while Eurozone government bond markets find a new level away from zero (in 10-year German benchmark securities as a proxy level, by way of example).

Equities in Europe had a more sober session. They were higher – and quite sharply for much of the session but closed in the red, with any early euphoria saved for the US market where eventually the Dow Jones Index hit a new record closing high (+1.2%). It looks like that will propel European stocks higher today and help end the week on a positive note.

Corporate bond primary market re-opens

Big issue/=: Gazprom weighed in with a deal

Big issue: Gazprom weighed in with €1bn

Any potential for panic also subsided (spreads were wider on Wednesday) in credit with primary open and several borrowers taking their cue from the risk-on tone elsewhere.

We had €1.5bn of issuance from Gazprom (€1bn) – a crossover rated credit, Gasunie (€300m) and a tap of €200m from Bunge Europe. They are also the only deals in IG non-financials this week and take the monthly total to a paltry €7.5bn. We’re still looking in a context of €20-25bn by the time the month is out. Finnish insurer Sampo was the sole FIG deal with a €750m 7-year offering. There was nothing from the high yield market.

In the secondary market, spreads recovered yesterday’s losses in IG, the Markit iBoxx index left at B+125bp but returns took a serious hit. For 2016 to date, they are now at 4.3%. Sterling spreads also tightened a couple of basis points from a cash index level, while the back-up in Gilt yields this week have returns dropping to 9.2% (as compared to highs of 17.2% a couple of months ago).

For the high yield market, we had some good tightening with the index level lower at B+417bp (-9bp) and returns holding above 7%. The HY index yield dropped to 3.92% (-2bp) as the front-end of the underlying only rose a little in yield.

Observing Armistice Day should leave us with a quiet session today – Lest we forget. Have a good weekend. Back on Monday.

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.