23rd March 2020

🗞️ Pyrites at the end of the primary rainbow

iTraxx Main

118bp, unchanged

iTraxx X-Over

705bp, +20bp

🇩🇪 10 Yr Bund

-0.38%, -4bp

iBoxx Corp IG

B+259bp, +10bp

iBoxx Corp HY

B+913bp, +25bp

🇺🇸 10 Yr US T-Bond

0.77%, -17bp

🇬🇧 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″]

Closing for business…

Another day goes by and it was another decent leg lower in for risk assets. Even with the Federal Reserve going all-in, becoming the ultimate back-stop bid for fixed income markets, failed to prop up risk markets. Classically, it ought to have translated into some material support across those very markets. It didn’t, coronavirus doesn’t listen, and we d0 not foresee see any significant improvement in confidence in risk assets anytime soon. Next up, though: the cavalry.

But the virus will hold out against it. The Republicans and Democrats can’t quite agree a Covid-19 economic package just yet. Until they do, we are unlikely going to establish any sort of floor for the markets. It’s amazing that we do continue to go lower, because the Germans also signed off on a €750bn package designed to help support stricken domestic companies, as well as including a chunk for additional social aid.

Credit markets are not spared – far from it. They continue to drift or ratchet wider (spreads) stunned by illiquidity in the secondary market and a huge fear of the unknown for this market once macro at least stabilises. That’s some way off, meaning that there is a lot of pain yet to come.

Primary issuance, if a window opens, is likened to being lured by a pot of fool’s gold. Plenty have (previously) got sucked in.

The higher-yielding section of the credit market has been the investor’s choice of interest through the decade-long era of low rates. This previous darling of the market was forced on the investment community by the lower rates regime and the direct manipulation of the corporate bond market (in IG) though the central banks’ QE.

Part of that trade saw investors play their part in helping to recapitalise the banking sector, lured in by the plentiful yield on offer in the various capital products, the most ‘interesting’ of which was the contingent convertible. Barely 4 years old, investment in this product has come back to bite them, hard.

Admittedly, pre-Covid-19, we were bullish even after the sector returned awards of 15% last year. However, now for investors in the contingent convertible bond market, the future looks extremely bleak. CoCos were “designed to fail” without triggering a bank default. That moment has come – or will do, very soon.

In a recent article, banking sector specialist and a former creditmarketdaily.com guest writer, GJ Prasad, wrote “… regulators should also ask all banks to suspend AT1 coupons as well and retain distributable reserves.  And not allow any calls for the next 1-2 years. AT1s may further drop in price as many more will want to exit as investors factor in 1-2 coupon deferrals and perpetual risks. But that is the price of getting involved in a product that had all the risks written in the offering document (and investors did not care to read) and having written nice optionality to the issuers.

And when they drop to the low 30s area and things get better in a year or so, (banks should) launch tender offers to convert into equity or for cash as it happened with legacy Tier 1s..In the meantime, significant downside prevails in this instrument that offers nice yield when you get it and stings like mad when risk sells off…. (that assumes there is) LIQUIDITY (if you want to get out).”

We had a tentative recovery in the AT1 market at the back end of last week, but it gave it all and a little more back in the session, the index widened by 115bp to reach a new fresh record high of B+1515bp. For the year – so far, that 1120bp wider.

Nope, not getting involved

The better bid in rates saw the Gilt yield in the 10-year drop (again) to 0.42% (-15bp). The Bund yield in the same maturity was only 4bp lower at -0.38% while the Fed action saw the 10-year Treasury yield decline by 17bp to 0.77%.

Equities saw the FTSE below 5,000 at the close as it dropped by 3.9%, the Dax closed at 8,741 (-2%) and, as at the time of writing, the US markets were up to their usual volatile trading and around 3.5% lower. There will be a sense of despondency at those moves given that the Fed has underwritten a massive part of the market and a government package is due imminently.

The high/low beta split in credit was demonstrated in the iTraxx indices with Main eventually unchanged at 118bp and X-over 20bp higher at 705bp, with the ratio between them now just about at 6x.

In cash, as well as that AT1 market weakness as highlighted above, we had weakness everywhere else. The ECB might have lifted €2,079m of IG corporate debt last week as its total haul rose to above €200bn for the first time (€200,165m), but we still saw 10bp of weakness in the IG iBoxx index which moved to B+259bp (and +156bp YTD).

The high yield corporate market widened by 25bp to B+913bp, which is still 1100bp tighter than the record wide from 2009. Back then, the market was a lot smaller (ca. €50bn), much more illiquid and therefore prone to more exaggerated moves versus now, where it is larger (ca. €350bn), still illiquid but in comparison moving in much more measured way.

Unfortunately, there’s more pain to come.

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.