15th September 2019

Rabbit out of the hat

MARKET CLOSE:
iTraxx Main

45.6bp, +0.6bp

iTraxx X-Over

238.3bp, +2.8bp

🇩🇪 10 Yr Bund

-0.45%

iBoxx Corp IG

B+119.5bp, -3bp

iBoxx Corp HY

B+391bp, -11bp

🇺🇸 10 Yr US T-Bond

1.90%

🇬🇧 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″]

Credit not the only winner…

Mario Draghi is a magician. There’s little doubt left. Judging by the post-ECB rally in risk assets, the great conjurer has pulled it off again. Increasing Eurozone wage growth, the Chinese relenting on pork imports (out of necessity, in our view) amid rising trade-tariff optimism, US retail sales on the up in August and no-Brexit all fed into the equation. It’s only left for the Fed to do its stuff later this week and we can conclude a very satisfactory quarter.

But hold on.

The ECB will have lowered funding costs, likely sustained macroeconomic growth at these depressed levels, will manage to keep the default rate at less than 3% and boosted the high/low beta compression trade. With it will come a huge amount of frustration as the central bank fixes a corporate bond market that isn’t broken. It has provided a stimulus which isn’t needed and will be likened to nothing more than an overdose.

And there’s been bit of a poke in the eye for rate markets investors, chasing safe-havens higher only to see a fairly painful reversal. We think it’s just the markets finding their feet, because there should be little doubt that we are due another assault on that benchmark 10-year headline bund yield seeing -0.75%, and most likely lower. In the meantime, the ECB’s latest salvo has reinvigorated the bid for corporate bond risk.

Cash-rich corporate bond investors might right now be content with copious levels of primary activity which absorbs their balances – but should it dry up or slow, then we are in for an almighty squeeze. In addition, being forced into higher-yielding risk assets on the ECB’s impending return as the most unwelcome of marginal players may only be storing up trouble, perhaps, for some time in the future.

Buying high yield debt is not the type of asset one can usually hold and kick into the long grass.

There’s an added boost to supporting higher yield market valuations. And that comes from rising equities. The S&P is heading for record territory, again boosted by easing US/Chinese trade tensions, Trump’s attempt to reach out to North Korea again while the Iranian situation is seeing the first signs of calming.

Further, the correlation between equities and high yield markets will help the latter rally. The technical support for the latter (ECB QE) will also help the market rally. Credit risk notwithstanding – and the risks to the asset class seem idiosyncratic rather than systemic – spreads are going tighter, we would think. And quite possibly materially so.

The HY iBoxx index tight was back in November 2017 and reached B+254bp versus being marked at around the B+390bp level now. In IG, those numbers are B+83bp and B+120bp, respectively. So there is room for an outright tightening before we get to those previous record tights, and it will come courtesy of the ECB’s corporate bond purchases.

That will also likely see a compression in the yield between the two which reached a record low of 143bp, also in November 2017, but now resides at around 270bp.


Primary path cleared again

After a ‘temporary’ halt to proceedings last week, we are now in the clear for a resumption of primary activity – and it could be quite heavy, even if we have had more of our fill in the previous couple of weeks.

Still, deals were on the screens post-ECB in Friday’s final session. In the IG non-financial sector, Kerry Group issued €750m in a 10-year maturity at midswaps+78bp. The book was up at €2.6bn and final pricing was 22bp inside the initial price talk.

That deal took the monthly total to €28.3bn and the year to date total to over €230bn. Given our comments earlier, we must be looking at €45bn – €50bn of issuance for the full month and most likely a record for the full-year – the target being €285bn (from 2009).

September’s impressive array of IG non-financial deals so far:

The rest of the deals to close out the week and bring us to the halfway point for September were in high yield. Altice issued €1bn in an 8NC3 structure priced to yield 3.375% and a further €500m in a 5NC2 effort priced to yield 2.5%. They also lifted $1.1bn in an 8NC3 to yield 5.5%. Finland’s unrated Cargotec followed up with €100m in a long 5-year at midswaps+165bp and €150m in a 7-year at midswaps+195bp.


Sense of crisis eases – Until the next time

One would be forgiven that any sense of macroeconomic crisis was forgotten or over as we closed out last week. On Friday, we saw that Eurozone wage growth in Q2 rose at its fastest pace in ten years, with nominal wages up by 2.7%. Sterling continued to rally as a no-deal Brexit seemed as far away as it has been since the referendum as the Establishment potentially litigates it to death.

And then the Chinese announced that they were exempting some pork and soybean products from tariffs as a goodwill gesture. It is of small coincidence that pork prices have risen almost exponentially in China and in order to contain runaway price rises for this important food, the need for greater imports has escalated.

Anyway, the 10-year Gilt yield has almost doubled in a week, now up at 0.76%. The 10-year US Treasury has bounced almost 40bp to 1.90% and the Bund yield has risen to -0.45%. Buy the rumour, sell the fact it seems. In equities, the S&P is holding above 3,000 and at 3,007 is less than a 1% rise away from a fresh record high.

Credit had a solid session in cash. Well, the amount of business was low but there is much tightening ahead of that purchase programme start. The bang for one’s buck is biggest in the higher beta sectors. In the last two sessions, the HY index has tightened by 25bp (!) to B+391bp – a level it briefly touched in April. Total returns are up at 9.4% this year – spreads have tightened by 132bp.

For IG, the index is now at B+119.5bp which was a 3bp move tighter for Friday and 7bp for the last two sessions. As suggested earlier, the compression between the two markets is already on.

It gets better for investors who invariably have a long high beta portfolio skew positioning. The AT1 market squeezed as well, the index 13bp tighter in last week’s final session to B+478bp – or 40bp tighter since Draghi’s press conference. The index is 100bp in the last 4 weeks and we haven’t seen a sub-500bp level since September 2018. Total returns for the euro-denominated AT1 market? 12.6% so far this year.

For this week, the Fed is in the spotlight with markets expecting a cut of 25bp but Powell’s post-FOMC  remarks will be closely assessed, given that 25bp is already priced in. Boris Johnson meets with Juncker on Monday, with the Supreme Court in the UK set to deliberate on the prorogation of Parliament on Tuesday. Happy hunting.

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.