11th February 2018

Nervous breakdown

iTraxx Main

55.9bp, +4.1bp

iTraxx X-Over

278.4bp, +12.6bp

10 Yr Bund

0.73%, -2bp

iBoxx Corp IG

B+86.25bp, +2.5bp

iBoxx Corp HY

B+297bp, +15bp

10 Yr US T-Bond

2.80%, -5bp

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=”10″], [wp_live_scraper id=”11″]

It’s just a definition…

A US equity market correction it might be, by definition. But now, we think that the market is just finding its feet amid some of the chaos created, and that we are not heading for something more sinister.

The second US Government shutdown in as many weeks was probably the reason for Thursday’s late big drop in equities, not helped by markets already feeling nervous from the previous sharp falls. The main focus for investors will be US equities and therefore it will be important we watch how they fare over the next few sessions in terms of judging whether to bottom fish for oversold risk assets, or just to put some cash to work in already long positions on the back of a better entry point.

We don’t think too many are going to be looking to reduce risk on any bounce. It’s too soon.

Until we get a period of stability in equities, we can look forward to quieter climes as far as the corporate bond market is concerned. That might come this week. A few deals will get through any cracks which develop, spreads should remain in a tight range (small up or down) unless European equities take a serious leg down (or up) but we don’t see there being any sense of distress or panic in the credit market. All things being equal, IG corporate risk has been extremely – and some might think unexpectedly – resilient.

IG cash spreads are still at around record tights, the high yield market hasn’t fallen out of bed as it once might have done given the correlation with equites it usually enjoys (felt painful on Friday though), and the bank contingent convertible market has barely moved – again until Friday’s session. Well, we don’t have a banking crisis, just in equity market-centric correction in valuations.

The driver for a material and sustained sell-off in spread markets is usually a – or fears of, financial market collapse emerging as a result of a systemic event which would necessarily pressure funding conditions, see a higher default rate and create a sense of panic. This, in turn, would support a bid for the ultimate safe haven – that being US, German, UK and Japanese government bonds. That’s not happening and isn’t likely going to be the case while macro is so supportive.

So we just have to – and will we think, ride it out. It will stem the one-way tide of tightening in spreads we enjoyed through much of January, but that’s no bad thing as new deals will come at slightly better (higher) spread/yield levels.

Equities dither

US stocks eventually finished with a flourish and sharply higher in last week’s final session, but the eventual 1.5% rise (in the S&P) hid many ills. It belied a massive level of volatility with equities dipping in and out of the red and black constantly and by some margin at times (+/11.5% or so). These are nervous times, but as suggested earlier, argue for the market trying to find it’s feet after some hefty falls from those record highs.

So there was finally a bid for safe-havens, and it was Gilts which outperformed whereby the 10-year was left with a yield of 1.56% (-5bp) with support coming after Barnier suggested that a transition period was not guaranteed. Sterling also took a tumble to trade-off a $1.37 handle, for example, and was also weaker versus the euro. Bund yields fell a touch, the 10-year to 0.73% (-2bp) with the Treasury rallying and the yield dropped to 2.80% (-5bp, 10-year).

Primary caught up in whirlwind

Looking back over the opening 6 weeks of the year, primary has really failed to move out of first gear. It likely has contributed in part to the spread performance of credit. We didn’t necessarily have a decent January with IG non-financial issuance at just €18.2bn versus our expectations which we had pitched up as high as €30bn. Then the equity market gyrations sapped confidence and along with the earnings season, has left February’s issuance at just €8.8bn in the opening week and half.

We have had almost as much as €40bn issued in previous February months but it is safe to assume that won’t be happening this time. Nevertheless, we could be looking at a very heavy March for supply should the markets finally settle and the borrowers feel comfortable to reach out.

The high yield market is chugging along nicely, delivering deals and some sizeable ones with it. Almost €5bn was issued in January and we have added €1.75bn to that total this month already with deals reasonably well received given the difficult market conditions. In senior financials, a blistering start – as always in January – seeing €21bn issued, has slowed massively to just one deal this month for €1bn from ING.

What we see this week is really going to depend on events outside of the control of the credit markets. But we saw some greater levels of apprehension in credit for the first time in a while.

And synthetics felt some pain on Friday. Maybe some were either throwing in the towel, or wanted some protection on the books going into the weekend. It didn’t help that US equities were extremely volatile in the week’s final session. Main rose 4.1bp to 55.9bp and X-Over 12.6bp to 278.4bp. These were big moves.

In secondary cash, there was a little more enquiry (to sell), but as always, nothing to fluster the market. The offered side was also lacking, by the way. The IG Market iBoxx cash index moved 2.5bp wider to B+86.25bp – to the highest level… since late January! Relative to equities and rate markets, IG credit continues to outperform. There was some extra weakness in the CoCo market, but the 25bp of index widening to B+351bp still left it 15bp inside the level that we opened the year with. And flows were light, with only market illiquidity ensuring we went wider by such an amount.

In the high yield sector, we saw material weakness but it was predicated on low volumes with a defensive Street bid the order of the day. The iBoxx index widened a massive 15bp to B+297bp, the highest level seen on this index since mid-December.

As for this week, we have a good opportunity to regroup as the fourth quarter earnings reports start to slow (Coca Cola, PepsiCo etc), we have US CPI and retail sales for January and the Chinese new year begins on Thursday.

Have a good day.

For the latest on corporate bonds from financial news sources, click here.

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.