23rd February 2017

A new normal

FTSE 100
7,302, +27
11,999, +31
S&P 500
2,362, -3
iTraxx Main
74bp, unchanged
iTraxx X-Over Index
295bp, unchanged
10 Yr Bund
0.28%, -2bp
iBoxx Corp IG
B+137bp, +1bp 
iBoxx Corp HY Index
B+376.5bp, +3bp
10 Yr US T-Bond
2.42%, unchanged

Steady as she goes…

Market reaction: What’s coming next?

If it looks like it and feels like it, it probably is. That is, an uneasy calm. Experienced market observers are probably of the view that the markets are heading for a major fall. They’re probably not sure what the trigger will be or when it might come, but believe that the pressure is building.

Further, there is a belief that we’ve become too complacent. After all, we have sailed through the “shocks” of Brexit and President Trump – and the market probably is positioned to sail through the next one which comes along.

The problem is, that view is difficult to trade. We would ask, what does a fall mean? Stocks off 10%+, 10-year Bund yields down at 0% again – and non-financial corporate bonds better bid while financials in the doldrums?

It’s not perhaps “normal” that we get through such major events like the UK referendum or the White House’s unlikely new resident with such relatively little altercation. But we have. We mentioned yesterday also that US stocks are trading off forward P/Es not seen since 2004. However, for the markets to sell-off sharp and hard we need a “systemic shock”. No financial system shock and we can’t see a major fall/correction – or “I told you so” moment. However, that’s not to say that we could get a slow burning decline or correction or re-rating of risk asset valuations.

But that would come if, say, the growth outlook needs to be revised lower or if rates (in the US) rise ahead of/more than market expectations. Our view is that the next big hurdle is the French elections. Marine Le Pen will make the second round, but the electoral system is such in France that the “other” parties will possibly gang up on the Front National and gain enough support to defeat her in the second round (or there will be enough abstentions that she sneaks through). If that doesn’t happen, then we might get our “I told you so” moment. But we’re not betting on it just yet.

What it does mean is that safe-havens will remain fairly supported so yields are not going to the moon. It means that equities will likely have a supportive bid on hopes that the economic recovery on the way on Europe is sustainable and the US adds to the global momentum once we see some of the new government’s dollars being spent.

Credit sits somewhere in the middle where there is a bid for higher-yielding product as we still hunt for yield, but that sidelined money only chases new deals because it is safer to do so (everyone else is doing it). The corporate bond market has become boring again.

Steady as she goes? Yes.

The data is good, so is some of the rest…

The day’s economic news flow was generally good (Eurozone inflation, German business confidence, UK Q4 growth, Lloyds Bank’s earnings) although the euro saw more weakness while bond yields headed lower for Bunds and Gilts. Equities had a slightly better/mixed session, helped by the record closes overnight in the US again. The DAX managed to break 12,000, but gave back some 30 points from the highs to close lower than that big figure by just a point!

The 2-year Bund yield saw record lows of around -0.92% in the session, before ending at -0.90%. ECB QE-related bond buying and jitters around upcoming elections and so forth are seeing a good bid for the front-end of most safe haven assets, thus the increasingly negative yield on offer. Cash is better under the mattress.

As for longer maturities, the 10-year Bund yield dropped as low as 0.25% in the session before backing up to 0.28% (-2bp) and OATs gained back some of yesterday’s losses to 1.01% for the 10-year (as the election candidate colluding started), leaving a spread of 73bp between the two. Gilts yields were lodged at 1.20% (-4bp)

Overall, we think the front-end of government bond curves will stay well-anchored while the longer maturities are locked into a 0.20-0.40% like range (10-year Bund) given the high level of uncertainties that we face. We can and likely will decouple directionally from US bond markets.

Credit draws a bit of a blank

There was a €1.25bn deal for Belgium’s KBC Bank

KBC (€1.25bn) and ANZ Bank (€500m) were in the market for senior financial issuance, and just as well, because the session drew a blank elsewhere in the corporate bond market. That was unexpected for a midweek, low news flow day when deals would have been well-received. It seems some might be willing the month to end.

In the secondary corporate bond market, spreads edged wider such that the Markit iBoxx corporate bond index moved higher to B+137bp (+1bp) and once again 3bp wider this year. Returns jumped though as the underlying government bond curve was better bid. Notably, the index yield fell to 1.15% – the lowest level this year.

The sterling market closed unchanged.

High yield also had a lacklustre session and we saw some weakness in valuations albeit against a backdrop of very little flow. The iBoxx cash index closed at 376.5bp (+3bp).

Finally, iTraxx Main closed at 74bp and X-Over at 295bp, both unchanged.

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.