9th August 2016

Madness of crowds

FTSE 100
6,809, +16
10,432, +65
S&P 500
2,180, -2
iTraxx Main
iTraxx X-Over Index
10 Yr Bund
-0.07%, unchanged
iBoxx Corp IG
B+123.5bp, -1bp 
iBoxx Corp HY Index
B+447bp, -5bp
10 Yr US T-Bond
1.58%, -1bp

Heavy lifting done, what now?…

Central bank intentions have been made abundantly clear. They want you to spend. Soon, we will be paying them to hold our cash. After all, when there’s more and more talk of helicopter money as a potential policy initiative to try and get some material fire power into consumer spending, then we know there’s much trouble ahead on the macro front. At the moment, they are sticking to the tried & tested formula – which has repeatedly failed, in the broader sense. Still, the BoE’s boost from more QE and monetary easing has had a material and immediate impact on spreads and yields but the 20bp drop in corporate index spreads in just three sessions is beginning to slow already, markedly. The Bank hasn’t even started to lift bonds yet. Sterling corporate bond index yields are now at historic lows, while we are not far away from observing the same as far as spreads are concerned.

In numbers, the yield on the sterling Markit iBoxx corporate index is at 2.37% and moved 39bp lower in just three sessions, although only 6bp in yesterday’s. The index spread has crunched 21bp lower to G+141.5bp and is now just 11.5bp off the record low recorded in March 2015. We think the heavy lifting has been done, and the yield and spread components are starting to see smaller moves. Nevertheless, they will still continue go lower/tighter. Actually, it follows the same dynamic we went through in Eurozone for eur0-denominated corporate bonds.

The moves might have been greater in the smaller sterling market versus when Draghi first announced a QE programme just over a year ago (didn’t include corporate bonds), but the second phase of the QE programme – taking in corporate bond purchases, has resulted in a record low euro-denominated Markit iBoxx IG corporate index yield of 0.87%, while spreads at B+123.5bp have 30bp to go before they see their historic tights. We won’t be at all surprised if (or rather when) that occurs (we think before year-end 2016).

Just to tidy up, sterling corporate bond returns for those who might be indexed are at a quite stunning 15.8% YTD, while the equivalent euro-denominated IG corporate index is returning an extremely respectable 5.8% for the same period. We’re looking for yields on both indices to go lower, the euro-denominated one to see 0.70% and sterling likely in the 2.10-2.15% range by year-end. For spreads, we look for both indices to go through previous record lows.

More supply not a gimme

The hope for the BoE is that their participation in the corporate market is enough to kick-start higher levels of issuance in the sterling corporate bond market. We stated last week that we don’t think that it necessarily will. As well as creating a market which can compete on more even terms with the manipulated Eurozone corporate market, the idea is that cheaper funding levels will lead to greater investment, more activity and ultimately help populate part of the equation which leads to higher growth in the UK.

Sounds easy, but usually, we need to the heavy lifting to come from the politicians with a cohesive policy being in place which fosters confidence – and gives us firm footing in which to work off. The UK economic outlook (and global for that matter) is bleak. Cheaper funding costs across the Eurozone – in place now for nigh on several years, have failed to elicit anything near the sort of investment needed to inject life into that moribund economy. The US might be seeing signs of life however, but low unemployment is failing to boost wage growth to anywhere near the levels full employment ought to. Something is amiss.

bmw-factorySo, the sterling non-financial IG corporate bond market has only once broken through £40bn of issuance in any calendar year and barely reaches £20bn on average of annual issuance. That’s an average month’s supply in the Euro corporate market. Last week, Vodafone was super-opportunistic, and others might too. We had BMW yesterday and we dare say we can expect other autos, telecoms and utilities to enter the fray. But we’re not looking for masses to get done. There is a difficult macro outlook to contend with, and if we use the Eurozone as a proxy – one observes that the ECB’s grab-fest has hardly set the primary markets alight there.

It also begs the question as to how much issued/raised necessarily will be recycled into the broader economy? We are sceptical on this. For sure, the likes of Vodafone and BMW have a natural hedge given the extent of their operations (the banks too – which have been prevalent) and these are the sorts of corporates that will be looking at sterling funding. But we have just reached only £10bn of issuance year-to-date. Here’s hoping we get to £20bn by the time the year is out. Still, on the plus side, the BoE will now be the major player in sterling credit, looking to lift £10bn and that will make sure sterling corporate bond markets (just like its euro brethren) will remain well-supported into 2017.

Record being broken – and not just in Rio

For credit market participants, all eyes on a Monday are on the ECB’s corporate bond purchase programme weekly update. The ECB’s total purchases moved up to €14.98bn (corporate debt which will permanently leave the market) after lifts of €1.76bn in the week, and leaving an 8 week average at €1.88bn. Last week saw €1.37bn of purchases and the week before €1.42bn. So, there is some acceleration in the run rate and that’s great going in this quieter month of August. We think the relatively heavy lifting is soon going to show up more in spread markets especially if they keep this pace up over the next couple of weeks (they only tightened by 3.5bp last week).

Sterling corporate spreads tightened – on a Markit iBoxx index basis – by just 1.5bp, after 19bp of tightening in the two sessions at the end of last week, post BoE. The index yield declined by 6bp and most of that obviously came from the continued strong rally in Gilts (see below) where records were broken again. Euro-denominated corporate spreads were tighter in the session too, the Markit iBoxx index lower at B+123.5bp (-1.5bp) as the inexorable grind towards the record low continued unabated. In high yield, the spread grind tighter continued (B+447bp, lowest since August 2015) and the index yield dropped to 4.01% – the lowest in 14 months.

Equities are doing their bit as they react to easy financial conditions amid hopes that the economic picture isn’t necessarily worsening. Chinese trade data wasn’t great but equities pushed on nevertheless with many indices at 12-month highs. The DAX still has another 300 points (or 2.5%) to go before it is even flat YTD. Mind, German stocks have been going great guns of late, clawing back losses that saw it 12% lower in 2016 just a few weeks ago.

In government bonds, UK yields dropped more and to new record lows during the session, the 10-year at 0.60% (-7bp) while the equivalent Bund closed unchanged to yield -0.07%. The Gilt yield closed at 0.61%. Dare we even start thinking that the 10-year Gilt is on the way to joining the ranks of the negative yielders? It might not even be a “long-term” trade to position for, given the rate of the decline in the yield. While Gilts were breaking records, Spanish Bonos were too, as the yield on the 10-year dropped below 1% for the first time in history to close out at 0.98% (-2.5bp); and, for good measure, the equivalent BTP yield was down at 1.12% (-1.5bp) – and also a new record low. And the global economy isn’t busted?

That’s it. Back next week. As a reminder, we’re usually only publishing on Tuesdays throughout August.

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.