31st May 2018

Nerves of steel needed

iTraxx Main

70.2bp, +0.9bp

iTraxx X-Over

309.2bp, -0.4bp

🇩🇪 10 Yr Bund

0.35%, -2bp

iBoxx Corp IG

B+132.6bp, -2.7bp

iBoxx Corp HY

B+394.8bp, -7bp

🇺🇸 10 Yr US T-Bond

2.83%, -2bp

🇬🇧 FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] 🇩🇪 DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] 🇺🇸 S&P 500 [wp_live_scraper id=”15″], [wp_live_scraper id=”16″]

June will make or break our summer…

We closed out May with the markets at a real inflection point. Hopefully, we haven’t passed it (to the downside) as we ponder difficult situations on several fronts all coming at the same time. There is drama and much intrigue in Italy. Inflation in the Eurozone for May was higher and some will hang on to that single data point as evidence that the ECB can safely conclude its QE programme by year-end.

We have a trade war on our hands as the US administration slapped import tariffs on steel after the temporary extension deadline expired on Thursday. Oh yes, it looks like the vote of confidence slated for Friday against the current Spanish government – following several convictions in the ruling party’s aides on the running of a corruption racket – which has a good chance of carrying a ‘no motion’ such that a new government will need to be formed. Or we are set for new Spanish elections. Oh dear.

The only bit of good news so far is that mid-June sees that Trump/Jong-Un summit in Singapore. Here, there is a good chance of this occurring given that the news flow of late around it has been positive although the net result of any meeting is still up in the air. For now, we choose to look on the bright side. The data point for May showing a rise in Eurozone inflation to 1.9% from 1.2% in April seems entirely oil-related.

The bigger picture remains difficult on Eurozone macro – and even more so now given that the trade war could get out of control. The expiry of the temporary reprieve granted to the EU, Canada and others from steel tariffs on exports to the US – where talks have failed – is a real poke in the eye for the markets. Immediately, some of the aggrieved parties – Mexico and the EU – have promised retaliatory action. The markets dropped but then recovered some of their poise and losses.

And then there’s Italy. The markets were looking to see out the closing session of the month exhibiting a much better tone which allowed BTPs to recover some more of their recent weakness (second session in a row). That came amid hopes that a new coalition government could be agreed thereby doing away with the prospect of further elections. The yield on the 10-year BTP fell to as low as 2.72% (around 23bp lower) and well-off that intraday recent peak of 3.40% seen earlier in the week. However, the yield backed up after news of that US import tariff and we closed out at a yield of 2.76% on the 10-year BTP (-19bp).

It was a public holiday in Germany on Thursday, so it was a very light day activity-wise, but the equity market was still open. The trade situation made for much weakness and the DAX dropped 1.4%, the FTSE by just 0.1% and US stocks lower by up to 1.2%, at the time of writing. The markets were flattish to higher before the news emerged.

Primary credit markets were closed again, in most cases leaving us with a quite dire period for new deals in these opening five months of the year in the investment grade sector especially. We managed to get a covered bond deal away, while in high yield we had the first deal in over a week from Marine Harvest, which took €200m in a 5NC3 structure at Euribor+215bp.

We think that June will start extremely cautiously. Friday has a good chance of being yet another weak session, although it will be light activity-wise as most will probably be focusing on the US non-farm payroll report (193k estimate for jobs added). The steel tariff situation will continue to develop and we are all going to have an eye the Spanish confidence vote following the corruption scandal there. The Italian situation has a good chance of rumbling on through the weekend which leaves the EU with a migraine of major proportions given that they are also contending with Brexit negotiations and now a trade war with the US.

That June 12th summit in Singapore seems like scant consolation if it happens.

Corporate primary grinds to a halt

The primary market has, without question, been impacted by the volatility in markets, coming from the various macro and geopolitical risks. It shouldn’t have been to the extent that it has, because we believe that many borrowers could still generally access the markets without giving too much away in price. The demand is still there and sidelined cash still needs to get some risk on board with investors close to or at portfolio limits for cash holdings.

Issuance has been very poor in these opening five months of the year in IG non-financials. We haven’t broken through the €100bn barrier for the first time since the crisis peak in 2012. Yet we don’t have a crisis now, as such. There’s stuff going on, but no crisis. So at just €95bn, we’re around 30% down in supply versus the corresponding period in 2017. The average of €250-260bn of the full year 2014-2017 looks a long way off for this year. As for corporates needing to fund, we would think that in many cases they don’t need to, having extended the maturity profiles. They are also holding record levels of cash on the balance sheet – which needs reinvesting. They can wait.

High yield primary has also been affected by the general malaise coming from weaker macro, difficult geopolitics and the subsequent volatility, but it is still the outstanding primary market story for 2018 so far. The interest for primary high yield is as good as it has ever been, but deals have been few and far between into the second half of May.

Our January 2018 forecast for the full year of issuance to come in at around €55-60bn is already at risk, with the deal total to the end of May at €35bn. Much is now going to depend on the volatility and valuations in broader markets, but investors seem willing to add more high yield risk – should volatility recede – bears a constructive bias. If we can get through June with a total closer to €45bn, then the full year has a €70bn+ target in view.

Senior financial issuance is still running at a similar rate to that of 2017, with the opening five months of the year delivering €69.5bn of issuance. The pace of deal flow has slowed in May and we do expect that to slow a little more from here, as it usually does. The level of issuance will also depend on market conditions, and volatility around peripheral markets will not be conducive to senior financial issuance as investors baulk at adding senior financial risk.

So much is up in the air

While we waited for news from Rome it was clear that markets were hoping for the best, hence a temporary reprieve for risk assets. Equities were playing it with a straight bat and trading out flattish in the most lacklustre of sessions. Unfortunately, the US government’s imposition of import tariffs on steel set the scene for a sell-off, although most markets managed to close off their lowest levels for the session. There was no knee-jerk major sell-off. It promises to be an altogether different dynamic next week.

The 10-year Bund yield closed 2bp lower at 0.35%, the US Treasury was a touch lower at 2.83% (-2bp) while the equivalent maturity Gilt was left at 1.23% (-2bp).

In credit, the indices closed with Main up a little at 70.2bp (+0.9bp) and X-Over unchanged at 309.2bp (-0.4bp), in a quiet session with the market barely reacting to the unfolding events elsewhere. In all, the rising cost of protection has highlighted the growing macro and geopolitical risks so evident in May with Main higher by 16bp and X-Over up by almost 40bp in the month.

In cash, the Markit iBoxx IG cash index was lower at B+132.6bp (-2.6bp) reflecting a slightly better bid in the session, albeit with little occurring from an activity perspective. IG credit lost 0.25% in the month in total return terms on spreads a massive 29bp wider for this cash index! Sterling credit, as measured by the iBoxx index widened 17bp in the month (to G+160bp) but total returns were positive at 0.1% on the back of the huge Gilt rally.

Finally, in high yield, spreads were 7bp tighter with the iBoxx index at B+394.8bp – still some 75bp wider in the month. The weakness doesn’t reflect the fundamental demand environment, but with few obvious buyers into the volatility any selling cares are met with a defensive bid – hence the weaker marks. The severe poor levels of liquidity in secondary will always lead to disproportionate moves in secondary market valuations. Returns for the month? -1.4%.

Have a good day.

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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.