3rd April 2017

March into April – What to expect

FTSE 100
7,323, -47
12,313, +56
S&P 500
2,362, -5
iTraxx Main
73.6bp, -1bp
iTraxx X-Over Index
290bp, -0.5bp
10 Yr Bund
0.33%, unchanged
iBoxx Corp IG
B+129.5bp, -0.25bp 
iBoxx Corp HY Index
B+367.3bp, -1bp
10 Yr US T-Bond
2.39%, -3bp

That was then

The key takeaway of the quarter just gone is that the market fears little. Article 50, the EU jockeying for position as the Brexit negotiations are about to begin and arguably disappointment around President Trump’s opening salvos have been brushed aside. We’ve been focused on the economy. And economic growth can – and usually does – mask many of the difficulties we might have otherwise encountered elsewhere.

We have sailed through a Fed rate hike and speculation on whether we are going to have two or three more this year has failed to elicit a sell-off in Treasuries. The ECB is to be reducing its monthly purchases (from €80bn to €60bn) and yet fixed income assets (corporate and government bonds) in Europe are holding firm.  Equities have had a good quarter of it, higher yielding credit has done extremely well, while government bond markets are only exhibiting moderate weakness.

This is now

Taking the fearless market outlook with us into the second quarter leaves us thinking that we might emerge in decent shape as we close out the first half.

The biggest risk to the markets will be the French Presidential elections, with the voting to take place for the two rounds in late April and early May. Collusion there in the second round – should Marine Le Pen get into the play-off, will make it difficult for her to cross the finishing line. Unless the polls have again got it spectacularly wrong. Surely not. The news flow around the Brexit negotiations are going to have little lasting impact on markets, not while the hot air is being released.

So we focus on the economy where growth has held up, albeit at still fairly low levels, but the trajectory everywhere is upwards. Inflation numbers have recently disappointed in the Eurozone, but that’s no bad thing for investors hoping that ECB policy stays as accommodative as possible. Reduced bond purchases from this month might have some impact on how fixed income markets perform, but we’ll wait until we have series of data before we can conclude that their heavy-handed manipulation was the chief reason why credit spreads exhibited little or no volatility – or weakness – through the UK referendum and US elections. After all, lifting nigh on €75bn of IG debt in 10-months (or 10% of the eligible market) ought to have seen us materially tighter. We haven’t been.

We still like the corporate bond market; We’re on a surer economic footing, but there is little or no sign of investors beginning to change strategies in favour of growth rather than staying in more defensive fixed income assets. We’re therefore minded to keep it as it is: slightly long duration, a clear bias towards a higher beta portfolio positioning (get down that rating curve), and an increased allocation to financials (economic recovery and potential for steeper curves eventually).

Corporate primary in the ascendancy

March saw the best month for primary issuance this year for investment grade and high yield markets as they dished up €37.2bn and €10.3bn, respectively, although senior financials also had a good month with €17.2bn of debt issued. Most notable was VW’s €8bn four tranche foray as it rediscovered its mojo following an enforced 18 month scandal-induced absence. The total for the first quarter for IG non-financial issuance exceeds €85n and sets us up nicely for a year where €240-250bn is possible.

In HY, we’ve only had 5 months since 2014 which have exceeded €10bn and we could expect €45bn+ now on the current run rate for the full year of euro-denominated non-financial HY issuance. The pipeline is considerable and we have at times had a lull in the market. With macro more supportive and investors likely more confident (it helps that the default rate isn’t looking to go anywhere higher from here – and is lodged at around 2%) and interest in higher-yielding corporate risk still resolute, there is much appetite for more issuance.

Our expectations are that we could potentially get a couple of decent weeks in before we get a slowdown into the French elections, and then any market volatility between that first and second round of voting might see a reduced level of issuance. Still, if it looks like Le Pen is not going to win, the market remains open right through and will be the penultimate major event risk bogey the markets will need to concern themselves about this year.

Forecasts for April? Easter splits the month and we have the school holidays to contend with. We would think that somewhere of the order of €20bn for IG non-financial issuance and €5bn for HY.

Performance playing out relatively well for all

Equities have had a superb opening quarter with the €Stoxx50 returning 6.3% and the DAX some 7.3%. They both languished for much of 2016 before bit of a late comeback as we closed out last year.  Now they are making up for lost time, with German equities particularly in the ascendancy on hopes that the Eurozone is back on an assured growth footing. The FTSE hasn’t done too badly amid Brexit concerns and some currency volatility, and is up 2.6% in the opening 3-months of the year.

The US stock indices have hit a multitude of closing highs in the quarter, but dithering over Trump and the number of rate hikes that the Fed might execute this year have prevented them going much higher – although forward P/E valuations are very stretched. With all that, +5.7% for the S&P in Q1 represents a very good result.

In fixed income, Eurozone sovereigns lost 0.4% in March after a +1.1% return in February, leaving the opening quarter’s overall total returns at -0.6% as they make a slow recovery from sharp January losses. We happen to believe that this is a decent performance given the potential for a growth, inflation and higher rate dynamic the asset class faces. For sure, fixed income is going to feel some performance pressure in 2017.

In credit, the Markit iBoxx IG corporate bond index closed the month at B+129.5bp – or 8bp tighter in the month. Investment grade returns as measured by the index were down 0.6% in March and at just +0.1% for the quarter. The poor performance came from non-financials (-0.5% in March, for example), while financials have had a better time of it and are up 0.55% in the quarter albeit after a flat March.

Sterling corporate credit is the outperformer. Spreads might have been a touch weaker in the quarter, but returns have improved each month this year to close out the opening quarter of it at +1.9% as Gilts have sustained a good bid – especially through March.

Similarly, the high yield market has had a very good time it in 2017 and returned 1.6% for investors while spreads on the index are almost 50bp tighter.

As for this week, we have the French Presidential debates to look forward to, Trump meets China’s president Xi and we have the non-farm payroll report closing us out on Friday.

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.