23rd February 2020

🔻 Market being shaken out of its complacency

iTraxx Main

43.0bp, +0.8bp

iTraxx X-Over

219.6bp, +5.1bp

🇩🇪 10 Yr Bund

-0.44%, unchanged

iBoxx Corp IG

B+100.4bp, unchanged

iBoxx Corp HY

B+328bp, +2bp

🇺🇸 10 Yr US T-Bond

1.47%, -5bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”24″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”25″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”26″]

Nervous breakdown…

The coronavirus is taking a greater grip outside of China now, and the economic impact is being felt are widely. More and more, it appears that macro won’t catch up with the loss of activity we are going to experience in Q1 and very likely in Q2.

The Chinese are now briefing that the economic impact (export/imports) will be severe in January and February. The IMF, over the weekend, shaved 0.1% off its 2020 global growth forecast to 3.2% and 0.4% off Chinese growth to 5.6%.

Markets ended last week on the defensive but continue to trade on hopes that the authorities can get it under control quickly and/or that central bank action is nigh which will save the day (sustain asset prices) for a little longer. It was a big preliminary PMI data release day on Friday. The picture was bleak.

In the US, manufacturing’s expansion slowed with the PMI for February up at 50.8, missing the 51.5 expectation but the big blow came in services where activity contracted (PMI at 49.4 versus estimates pitched up at 53!). The last contraction was in March 2016.

Japanese activity has also fallen off a cliff according to data. Services contracted sharply in February with the PMI for the month coming in at 46.7 (51 previously) and manufacturing activity worsened (47.6 versus 48.8).

For the Eurozone, we saw improvement, with the decline in manufacturing easing to 49.1 and services up marginally versus last time at 52.8. It was a mixed picture amid still ongoing weakness, however. French manufacturing PMI came in at 49.7 versus 51.1 previously but services improved, to 52.6 (from 51.0).

Germany recorded a surprising bounce in activity. The manufacturing activity is still declining but at a slower pace as the PMI rose to 47.8 versus expectations of a further larger drop to 44.8. The UK saw expansion manufacturing against expectations of a small decline as services also held up.

Anywhere showing a bounce in activity all looks like it will be short-lived, and few will be kidding themselves.

Rates are reacting. The 10-year Bund yield is now at -0.44% (-0.20% at end 2019). Looking at it from here, admittedly early doors as far as 2020 is concerned, 0% (the forecast by many by year-end) looks impossible for this year and -0.70% is the more likely next big target. In the US, that 10-year yield dropped to 1.47% (-5bp) during the session, as equities dropped by over 1%.

In credit, we’re now seeing some ratings action. That’s either emerging because of a direct hit that corporates are taking from a loss in revenues from the disruption in supply chains and revenue growth (autos, for example), but we’re seeing action – or will be, more broadly, on slower/lower growth dynamics. Ratings transmission risks are increasing, that is.

The default rate will ‘edge’ higher, but in itself will not lead to any obvious weakness in the high yield market. We will see more fallen angels and downgrades within IG and HY ratings categories. They will not necessarily see any significant change in prices. Investors will put up with a rating cut or two.

As if to highlight the issue, Renault SA‘s downgrade to sub-investment grade last week (by Moody’s) only saw modest weakness of around 20bp or so in spreads (it might be more if S&P follow suit). In the grand scheme of things, that is noise, and we would expect a correction tighter in due course once the Street realises there is no need to be so defensive on the bid as few bonds emerge.

There’s little choice but not to sell, such is the scarcity of alternative corporate bond investments. Sell and one is damned – stuck with holding cash unless their next trade is an expensive alternative lift. There hasn’t been the ability to switch at a reasonable price for many a year.

Secondary market liquidity has been poor for years and it has created a ‘buy and hold’ corporate bond market. So, unless macro catastrophe strikes, volatility and weakness in stocks will not necessarily elicit the same reaction in the corporate bond market.

Risk on the defensive

So US equities lost up to 1.8% (Nasdaq) while European markets closed up to 0.6% lower and the reason was the coronavirus’ spread and the economic impact being felt now. In rates, US yields tumbled with the 30-year closing at just above its all time low of 1.92%, while 5bp were clipped off the 1-year leaving it yielding 1.47% at the close. There’s room – and rates cuts are coming.

The 10-year bund recovered to close unchanged at a yield of -0.44% while the Gilt in the 10-year closed to yield 0.57% (-1bp). Gold continues to rocket higher, now at $1,646 per ounce (+$25.5) as fears for global macro heighten.

In credit, we had deals from Santander UK Holdings which issued €750m in a 5NC4 at midswaps+73bp (-17bp versus IPT), while Wales & West Water issued £250m in a long 21-year at G+103bp (-12bp versus IPT). That was the day’s only primary activity.

The IG non-financial issuance is now up at €50bn with a week to go before we close out the month and compares well to the near €55bn issued for the opening 2-months of 2019. March last year saw issuance of €31bn and, as things stand, with the potential for a bit more volatility in the markets over the next few weeks, we might struggle to get to that level of volume.

At €22bn for the high yield market year to date, issuance is already up past what was printed in the opening third of 2019 (€20.3bn). And the pipeline looks good. Again, it’s the same argument as it is for IG issuance. Any material market volatility and we will see activity severely curtailed.

In secondary, spreads closed unchanged in IG, the index (iBoxx) at B+100.4bp as the market pulled in its horns amid the equity weakness. There was some weakness in the AT1 which was understandable given the correlation with equities, but the index only edged 7bp wider to B+346bp. The same went for the high yield market, the HY iBoxx index at B+328bp (+2bp) at the close.

In the US next week we have Q4 GDP (forecast 2.15%) durable goods consumer spending and core inflation. In Europe, German GDP for Q4 on Tuesday will be closely watched and we have some Eurozone services sentiment and consumer confidence data, in an otherwise fairly limited week for any meaningful macro data.

Have a good day.

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.