18th July 2016

Shoulder to shoulder

FTSE 100
6,669, +15
10,067, -1
S&P 500
2,162, -2
iTraxx Main
iTraxx X-Over Index
10 Yr Bund
0%, -5bp
iBoxx Corp IG
B+132.6bp, -2bp 
iBoxx Corp HY Index
B+466.5bp, -3bp
10 Yr US T-Bond
1.55%, +2bp

Stop, look and listen…

The tragic events in Nice last week seem to have created a feeling that we are needing to finish up for the summer. The attempted coup in Turkey over the weekend has further added to the sense of gloom. Going into last week, we expected two more weeks of decent activity but it looks like it has all come to a sad and premature close. The Bastille Day tragedy has our thoughts with the victims and their families. It’s been a difficult year to navigate, and the markets have been fraught with several periods of intense volatility this year. The opening couple of months of 2016 were as volatile and panic-ridden for many a year, while the calm and subsequent recovery in the March-May quarter failed to hold into a difficult pre/post-Brexit referendum month of June. That has carried on through July.

Specifically for the credit markets, last week’s primary markets activity was a damp squib. We hope for and need buoyant primary. It keeps investors interested and sometimes excited. Whether to buy, looking at fair value, deal sizes, using up cash, the development in new issue premiums and so on. But the non-financial IG market has not even seen €7bn of supply and senior financial/high yield debt issuance has been extremely light so far this month. No one, final pre-summer hurrah here it seems. In the meantime, that low level of issuance is forcing investors to hang on to what they’ve got. One dare not let anything go. It means a more aggressive bid is needed for anyone looking to add through secondary. And we have the most desperate of investors looking for – and needing – corporate bond risk. Yes, the ECB.

Spread markets ratcheting

And so spreads in the last few sessions are crunching tighter, offsetting much of the back-up we might be getting in the underlying yield, thus keeping total returns for credit elevated. Benchmark players are also having a better time of it too, finally. The Markit iBoxx IG corporate bond index now sits at B+132.6bp and was 2bp tighter in Friday’s session – and a stunning 15bp tighter in the week. It is no coincidence that there has been little supply while the ECB is looking to bolster the number of corporate bonds it holds on its balance sheet. The index yield edged up though, but only 1bp in the session to 0.99% (2bp off the record low seen on Wednesday).

How low can it all go? We would think that front-end yields are fairly anchored, and because we believe the ECB’s buying power will distort the spread markets better, another 30bp lower in spreads between now and year-end could see that index yield at 0.70%. We hope we are at the top end of expectations, because more than that would heap massive frustration on the investor universe, as well as result in a severe amount of risk with participants engaged in the market who do not necessarily have the requisite skills to manage it. That is, more investors forced down the curve and into longer duration credit risk.

Still, some comfort comes from the performance being achieved and the index is already returning a quite extraordinary 5.1%. We were thinking 4-5% was a reasonable expectation just several weeks ago, but 7% or more is what we could be looking at if the current process/trend plays out as we expect. That would be one of the best years ever for the corporate bond market in terms of performance in IG corporate bonds (see chart).

Investment Grade Corporate Bond Total Returns

Mid-July has credit in the mix

Taking a look at state of the markets mid-July sees stocks in the ascendancy (especially in the US), corporate bond markets following close behind and safe-haven assets (government bonds) under some pressure as their lustre fades a little into the risk-on nature of the last week. The recovery has been very good with the DAX even back up through 10,000 and down just 6% or so YTD, the US indices are at around record highs and the FTSE index has done away with most of the Brexit-related fears of a cataclysmic drop. Government bond yields have backed-up too for the moment, and we closed Friday with the new, on-the-run 10-year Bund yielding 0% (+4.5bp), the equivalent Gilt at 0.83% (+4bp) while the 10-year US Treasury yield edged to 1.53% (+1.5bp). We might see some reversal of that when we open for business today following the events over the weekend in Turkey, with some maybe preferring to take up some defensive positioning.

The IG market has had a super month with cash index spreads 20bp tighter in July already. Actually, the HY market has also has a decent time of it, too – and without the help of any direct manipulation of the ECB. Index spreads are showing a decline of 44bp in just two weeks – amid little flow, volumes, and supply. And the technicals continue to look very good. The Markit iBoxx HY index yield has also squeezed better, dropping to 4.22% (-40bp in the month so far) amid little issuance (less than €1bn last week) to put pressure on spreads, while interest has mostly been to add risk as equities jumped higher and sentiment overall for risk was on the up.

This week sees the earnings season in the US move up a gear (BoFA, Yahoo, Intel and Microsoft, for example are due) and we also have detail on the ECB’s specific holdings later in today’s session. The transparency offered by the latter will be interesting as will the size of last week’s buying spree given that the heavy lifting of the first three weeks of over €2bn/week dropped in week four to just over €1.6bn. The ECB’s monthly meeting comes later with little expected to change in terms of additions to current policy.

Back tomorrow. 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.