3rd June 2019

Nerves jangling some more

iTraxx Main

70.5bp, -0.4bp

iTraxx X-Over

307.7bp, +0.5bp

🇩🇪 10 Yr Bund

-0.20%, unchanged

iBoxx Corp IG

B+144.8bp, +0.7bp

iBoxx Corp HY

B+471.8bp, +8bp

🇺🇸 10 Yr US T-Bond

2.12%, -2bp

🇬🇧 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″]

Turning Japanese, again…

The Japanification of the bond market is all the rage. Those yields continue to tumble and participants see no way out of the low yields for longer dynamic, as we tumble into another downturn/recession having barely managed to pull ourselves out of the last one.

That 10-year Bund yield, breaching record lows with little chance of getting back into negative territory anytime soon (now at -0.20%) looks set on -0.30%, and quite possibly -0.40% should the ECB need to provide markets with some additional policy assistance. That’s that then. So we move on to the corporate bond market. A few years ago, we remarked that the low interest rate environment (courtesy of the financial and Greek crises) was leading to the Japanification of the corporate bond market.

There’s a Japanification effect occurring in the corporate bond market in that corporate bond yields are low (not at historic lows) and generally heading lower again, pulled down by the rally in underlying government bonds – but whether the levels are maintained or not depends on the corporate bond spread. So we don’t get a ‘pure’ Japanification impact of the corporate bond market, as they don’t enjoy risk-free status.

What we do get though is lower corporate bond yields, corporates tend to enjoy lower funding costs as a result and investors tend to favour longer-dated corporate bonds and/or higher yielding debt. We get flattening curves and/or high/low compression.

We saw the compression trade in the 2012 – 2014 and 2016 – 2017 periods courtesy of the Eurozone crisis and ECB QE purchases, respectively – and it appears that we’re getting some of the same now courtesy, as mentioned, of that crunch lower in the underlying. As measured by the iBoxx index, the HY-IG differential got as low as 150bp in November 2017 before rising to almost 400bp in late 2018. Since then, we have trended lower and currently reside at around 310bp.

The ECB’s bond purchases were the clear driver for the record tight differential (IG crowding out effect) but even without the direct assistance of the central bank, we are seeing some sustained compression in 2019. It is unlikely that we will get close to those levels again and a weakening macro outlook doesn’t auger well for high yield market sentiment (which by the way are highly correlated with the direction in equities).

As well as a difficult macro outlook, several other factors are at play which suggest a more laboured compression. Firstly, there’s no marginal buyer forcing the compression (ECB previously). If we therefore consider that it will come unassisted, the compression trend will be more laboured and dependent on volatility in equity markets.

Fundamentals are generally supportive even if we have had some increase in single name event risk, while the global default rate remains at low levels. So we wouldn’t necessarily chase it, but we see the lure of higher-yielding assets and would still retain a broad bias towards positioning for compression.

It’s Monday, what else?

Turning the page into a new month, we moved effortlessly over the line into it as we endured another choppy session. But nothing too disastrous – we ended higher in equities – and more like we might expect for a Monday, from an activity perspective anyway. Equities gained late onto the European session to end higher for the day, rates generally entertaind a better bid and credit primary was closed, while secondary was also mostly sidelined.

If Tuesday’s session appears like the one just passed, then we won’t be surprised if a corporate borrower or two chances their arm. After all, relative stability after a week long lull (just one deal in IG non-financials last week) will be enough to get a borrower on the tapes.

The data served to highlight the difficulties the trade dispute is now starting to provoke. The UK’s factory sector contracted for the first time in 3-years (PMI 49.4). The Italian sector shrunk for the eighth month in a row (49.7, consensus was 48.6). In Japan, the manufacturing PMI slipped to 49.8 in May. Capping it off, in the US, May’s manufacturing ISM came in at 52.1 versus forecasts of 53.0 and April’s figure of 52.8.

The reasons are broadly all the same – the global slowdown. But lazy thinking or otherwise, the UK’s contraction was no doubt blamed on Brexit, in Italy on the Eurozone slowdown and domestic political angst while in Japan, the Chinese slowdown amid the tensions in the US/China trade dispute.

European equities closed up to 0.6% in the black, having seen losses of the same magnitude earlier in the day. The US markets were similarly lower at the start but were fighting back, as at the time of writing, left mixed (small up/down) depending on the index.

Duration’s better bid faded into the close, but we still saw the 10-year Gilt yield lower at 0.87% (-1.5bp), the US Treasury yield dropped 4bp to 2.10% on the same maturity benchmark while the Bund closed to yield 0.20% (unchanged). The Fed’s Bullard gave a boost to Treasuries suggesting that rates might need to be cut soon as the Fed grapples with the trade war, weakening global growth and subdued levels of inflation.

In credit, with nothing happening in primary and a defensive market elsewhere, secondary activity was light and the market probably better offered, for choice. The Market iBoxx IG cash index closed the opening session of the month at B+144.8bp (+0.7bp) and B+477.8bp (+8bp).

Finally, on index, iTraxx Main closed at 70.5 and X-Over at 307.7bp and both unchanged.

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.