- by Suki Mann
|🇩🇪 10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|🇺🇸 10 Yr US T-Bond
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But let’s talk credit…
The here and now has us thinking that surely the credit market must be on for some kind of spread tightening squeeze into the end of the year. We have flattered to deceive all year with spreads initially tightening and then widening and now spending months in some kind of holding pattern. They have been rangebound for an age! We know that investors have oodles of cash stashed away in their portfolios and are looking to get it invested – and we know that the primary market is the preferred route to get that money to work.
But the new issue market has failed to deliver this year, and it is increasingly looking like September’s deluge was a one-off.
In any other year, the balance of supply versus demand being tipped towards the latter would have heralded a serious tightening in spreads. It still might if investor ‘desperation’ increases in the final weeks of the year.
The first week of October has not delivered in primary – even if we wrote off activity on Wednesday due to the German holiday. Eight per cent plus portfolio cash holdings is too high and we ought to be thinking in the context of up to 3% come the end of the year. But investors won’t necessarily pile into ‘unworkable’ investment decisions, there’s always 2019 to look forward to. Hence we could be in a holding pattern of sorts, circling like, before being given permission to land.
Nevertheless, if the primary deals do not materialise this month in decent volume, there is a good chance they won’t in November. And then it might be ‘spread squeeze’ time. It could also be that we have read primary wrong. That the average of €250bn – €260bn of annual issuance in the 2014 – 2017 period seems like it was not a harbinger for 2018’s supply – or for that matter for a longer-term annual level. Funding disintermediation may simply have run its course.
The debt capital markets have had a glorious run since the crisis erupted. We could probably all agree even that the last 10 years (2014 – 2017 in particular) have by and large been bull markets for credit even if there were a few hiccups along the way. The banks pulled in their horns, forced to in some ways by more onerous regulation which saw capital become more expensive for traditional banking operations (corporate trading and lending, for example).
So through the last financial crisis decade, corporates have shifted their funding in a significant way into the capital markets, enticed by ever cheaper levels but lacking an avenue to get it to work. Their investment route, that is, has been blocked or hindered by the lack of any material, sustainable economic recovery and low confidence to spend.
Investment/capex levels haven’t shot higher to make use of the cheap levels of cash on balance sheets. Much of the cash has therefore been reinvested in the markets in a form of double leveraging of corporate balance sheets.
Now? The corporate sector isn’t playing ball. Hence the lower levels of primary market activity. We are well down on the levels of the past few years in IG non-financial issuance. Corporates don’t need the cash, perhaps. If so, it could mean that we are heading into a period of lower IG non-financial primary issuance. Right now, that ought to mean that squeeze in corporate bond spreads into year-end!
Primary still stuttering
Well, well, well. Another deal pulled. This time from Volksbank Wein cancelling an AT1 offering. That’s three deals pulled inside two weeks with the markets baulking at some of the testier transaction. Good.
Issues that did get away included Aeroports de Paris as the only IG non-financial issuer, coming with a 20-year €500m offering at midswaps+65bp (and -25bp versus IPT). All being told, it’s been a poor week for IG non-financial issuance – and not the start that we looking for – with just three deals, the other two from Amphenol Tech (€500m) and a tap from Total SA (€200m).
The high yield market had Bilfinger print €250m in a 5-year priced at 3.75% and adds to the €250m Warner Music printed earlier as the week’s only deals in the euro-denominated high yield market, so far. Playtech’s €530m deal looks like being Friday’s business.
In financials, we had auto fleet leasing group ALD SA print a 4-year €500m green bond at midswaps+100bp and Mizuho took the same in a 5-year senior transaction at midswaps+58bp.
Deutsche Telekom opted for sterling, with £300m in a 7-year at G+120bp and Romania followed on from Albania’s deal earlier the week, with a 10-year and 20-year dual-tranche offering of its own for €1.15bn (midswaps+195bp) and €600m (midswaps+270bp), respectively, on combined books of €2.8bn.
US macro out in front, but rate jitters increase turmoil
In the meantime, the US is blazing a trail. Service sector growth last month shot higher at a record pace, while factory orders grew at their highest pace in almost a year in August. The ADP employment survey on Wednesday suggested solid levels of job growth are not coming to an end anytime soon. The economy thus is nailed on heading for 4%+ growth this year and inflation appears contained at the moment. It looks more robust than some might think and the US equity markets are liking it – although unnerved of late from the rapid rise in US yields.
The high level of domestic self-sustainability will work in the US’ favour as Trump continues with his isolationist policies – and it is for others now to re-adjust accordingly. And the Fed might have given something to both the doves and hawks at the last meeting with regards the pace of future rate increases, but they can afford to be more hawkish, emboldened by the recent crop of data.
The dollar’s recent strength therefore looks sustainable and market rates continue to rise (very hard on Wednesday), but it is storing up a whole gamut of problems for emerging market borrowers. Higher US funding rates and a stronger dollar is the double whammy EM borrowers could do without. It’s been a slow-burning fuse for too long, time for a blowout?
In Wednesday’s session, yields shot higher (+9bp) with US Treasuries now yielding 3.20% (up another 4bp in Thursday’s session). It’s having the effect of dragging European bond yields higher too, with the Bund in the same maturity up at 0.52% (+4bp) and Gilts yielding 1.66% (+8bp) – all ending at just below the session’s highs.
Those higher Gilt yields came as it was reported that September’s UK car sales fell a stunning 20% – and the EU was offering a Canada +++ Brexit deal. Manufacturers, though, were blaming it on Brexit. We don’t. We just think that there is a reluctance from consumers to make big-ticket purchases – especially autos following an extended period of high levels of growth in this industry. Even alternatively fuelled vehicles sales growth was moderate (less than 4%).
As if that wasn’t enough to contend with, the Italian situation rumbles on. News that the government would adhere to a lower budget deficit after 2020 seemed to assuage many market fears. That damned can got kicked a little further down the road! The 10-year BTP yield popped higher midweek to a 4-year high of 3.46% but did recover sharply before rising again to close Thursday at 3.33% (+3bp in the day).
The higher rates move put a brake on the US equity rally which had set fresh record highs on several occasions this week. Still, we would think that the general path of US equity is higher but by how much in any given session might depend on moves in the rate market.
There were some wild swings in US stocks in Wednesday’s session while on Thursday, they moved sharply lower on continued rate market concerns (off 1.4% at the time of writing). The weakness in the US pushed European stocks a little deeper into the red, the FTSE being the chief underperformer, off by 1.2%.
In the meantime, higher yields will eat away at returns in fixed income and that includes credit, especially if the spread squeeze (on lack of supply, good demand and confidence from improving fundamentals) doesn’t materialise.
With just moderate weakness in continental stocks, we closed Thursday with iTraxx Main just a touch higher at 68bp (+0.4bp) with 5.1bp of weakness in X-Over, leaving it at 276.5bp.
And in the cash market, a quiet session still saw us out better bid seeing the iBoxx IG cash index edge 0.8bp tighter to B+130.4bp, although the index yield shot 5bp higher to 1.45% – and the highest level since Q1 2016. There’s a hidden subliminal message there for the borrowing side of the equation. Finally, the high yield market also was better bid for choice and the cash index was tighter at B+380.5bp (-4.5bp).
Have a good day.
For the latest on corporate bonds from financial news sources, click here.