12th December 2016

Markets wait for no one

FTSE 100
6,954, +22
11,204, +24
S&P 500
2,260, +13
iTraxx Main
73bp, -1bp
iTraxx X-Over Index
308bp, -4bp
10 Yr Bund
0.36%, -2bp
iBoxx Corp IG
B+136bp, unchanged 
iBoxx Corp HY Index
B+431bp, unchanged
10 Yr US T-Bond
2.47%, +6bp

And the ECB gets it…

One could have wished they had just made it easy for the yuletide season. Leave it all as it was and fight another day after the holidays. But the market waits for no one and the ECB just got on with it. A few will be rethinking their strategies for 2017, others reassessing their hopes and expectations. The one winner at the moment is the equity market. Much relief for those long German stocks has come this past week as the DAX has rocketed into the black (year-to-date). Better late than never.

US equities are riding high – record highs, in fact – while President-elect Trump can do no wrong, and he is not even in the White House yet. And the way the markets are positioned at the moment, they’re looking for great things.

Great things mean fiscal profligacy and higher economic growth. Last Friday’s University of Michigan consumer confidence survey attested to as much as it rose to a 2-year high. Trump’s election triumph was cited as the reason why consumers were feeling better about the future. There’s a lot hanging on to US economic policy in 2017. Spend, spend, spend means higher government bond yields in the US and, ultimately, higher rates. The hope is that growth is buoyant enough to drag the Eurozone and Asia higher, too. Fixed income markets could be in for a ropey year.

Whether fixed income feels hot under the collar in 2017 will depend on that US growth dynamic and the extent to which it can help global growth. Judging by the ECB’s projections, it seems that the impact might well be limited. The hope for fixed income markets – from a performance perspective – which comes with it, is that market yields move around in a limited range. We know that the ECB is staying involved in the market with its QE effort, in whatever form it takes after March (reduced but extended), so if the data doesn’t perk up we have a good chance of range-bound markets for government bonds.

Fundamental corporate credit quality doesn’t change at all under this scenario (where the Eurozone economy doesn’t blow too hot or too cold). We can feel comfortable that corporates retain some sort of safe-haven status should global events go awry. Furthermore, it is unlikely that we get negative returns in 2017. The drivers for those will be weak government bond markets (sharply higher yields) and/or material outflows from corporate bond funds with money chasing capital appreciation strategies (equities).

Monte dei Paschi di Siena bank: Time is up

But then there is the European banking system. The latest to fall in these recent crisis-riddled years is the oldest. Monte dei Paschi’s time is up. The life support machine is going to be switched off. Or at least it should be.

It didn’t happen this weekend gone, but we suspect one weekend in the not too distant future will see that happen. It ought not to be a ticking time bomb, but the bad loan problem at the heart of the Eurozone periphery-country banking system has needed addressing for many a year. With the ECB playing hard ball, bondholders will feel some heat in this specific situation while we can expect some contagion impact on junior debt elsewhere. Monti’s subordinated debt is trading at around “50c on the dollar.”

The Fed sees us out

The stronger dollar, a potentially hawkish Fed and higher yields don’t seem to have deterred US stock market bulls. The Dow recorded a new record closing level and 20,000 for the index is now in sight. We wouldn’t put it past the markets to try to push the index to that level before the year is out. The S&P closed at a record high and is returning around 10% this year. Whether we go higher might depend on what emerges from this week’s FOMC, as markets assess the number of rate rises we can expect from the Federal Reserve in 2017.

At 134bp, the 2s/10s spread in the US is pointing to expectations for higher growth, inflation and rates. US Treasuries took some more pain last week, closing just of the year’s higher for 10-year yields at 2.47% (+6bp). It is a similar story in the Eurozone but here it is less driven by growth expectations, rather more by the manipulative policies of the ECB’s quantitative easing programme. The 2-year Bund yield closed at a record low -0.79% (yes, minus 0.79%) while the 2s/10s spread was up at a stunning 115bp. As suggested above, we look for less movement in longer-dated yields given the potential for negative event risk supporting a safe-haven bid through 2017.

Gilts closed out under pressure and the 10-year yield up at 1.45% (+7bp), Italian government bonds will become an interesting trade with ECB support battling any ramifications of a Paschi closure. The yield on the 10-year popped through 2% to 2.04% (+4bp) on Friday with the periphery generally weak (Portugal 3.81%, +11bp).

As for credit, the cash markets closed completely unchanged save for much weakness on Monte dei Paschi debt, the subordinated 2020s down 7 points. The Markit iBoxx IG index closed at B+136bp and the HY one at B+431bp, and the index yields fell by 4bp to 1.29% and 4.04%, respectively. The sterling market similarly barely moved, the index closing at G+157bp but the sell-off in Gilts left the index yield at 3.17% (+5bp). New deals came from Carlson Wagonlit which raised €330m in the high yield market.

It will be a quiet week and any deals will be the last for 2017.

Have a good week.

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.