8th May 2017

Get ready, set… go

FTSE 100
7,297, +49
12,717, +69
S&P 500
2,399, +10
iTraxx Main
63.5bp, -0.5bp
iTraxx X-Over Index
255.7bp, -1.3bp
10 Yr Bund
iBoxx Corp IG
B+177.8bp, -0.5bp 
iBoxx Corp HY Index
B+330bp, -2bp
10 Yr US T-Bond

The path clears

President Macron it is – largely as expected, and an air of uncertainty from the markets has been lifted. Watch for the Bund-OAT spread move to inside 30bp and equities push higher in Europe – but not by the 4-5% we saw after the first round election result.

Credit spreads have reason to tighten some more into the better tone – but not by the 10bp we saw in the index in the week preceding the initial round of elections. The only difference for the corporate bond market is that the primary sluice gates will open, borrower caution will be blown away and we’ll get a plethora of deals this month to make up the shortfall and some more we had in a depressing April primary market.

So, it’s looking good for risk assets with another election out of the way. The German election is several months away and not too much to worry about through the summer months. We’ve seen off the Brexit vote, Trump winning the Presidential race in the US and now the French vote. The UK election is not really going to offer us anything new to be concerned about, except likely give Prime Minister May more of a domestic mandate in which to present her case to the EU.

Markets have brushed aside any of the aforementioned unexpected results and so should take the latest (expected) one in their stride. And macro is looking perky, meaning improvements – in corporates – in their credit fundamentals! It doesn’t get much better. However, we’re not going to get too euphoric or carried away with it, but there is little (save for a major geopolitical event) to stop corporate bond markets from continuing to perform from here.

And we continue to believe that rate insensitive higher beta risk is going to be the chief beneficiary (even into potentially slightly higher rates), and with most asset managers positioned with portfolios skewed towards higher beta risk, we’re looking at some potentially good returns for Q2. As measured by the Markit iBoxx corporate bond index, spreads in high yield are currently at B+330bp and we will expect them to soon test the B+320bp level saw in 2014 – which would set a new 10-year low spreads for this market. The high yield corporate bond index is 75bp tighter year to date.

Credit finds its mojo

Spreads are ratcheting tighter just when the various corporate bond QE purchases end (BoE) or are being reduced (ECB). Typical! But that is also against what we might have anticipated. And just as well we are going tighter given that market yields are rising, and so any spread performance is offsetting some of the price erosion.

Overall, the cash market is in good shape, helped in no small part by the lack of issuance we have seen since the beginning of April. We’ve also sailed through many potentially destabilising events and with macro now offering a net support to the market, the message is clear that the corporate bond market (spreads) have some life in them yet. And with low beta having been squeezed hard, we think the positioning will continue to favour higher beta debt.

The Markit iBoxx IG index has a B+117.8bp level and that was last seen in September 2016, albeit for just one session. We have tightened by 17bp this year – and that is about what we forecasted would be the most we might have seen for the whole of 2017. We tightened 4bp last week, and 14bp in the last two weeks alone. We might back-up at some stage predicated on some significant event, but the trend for now is a tightening one.

So a sub-117bp cash index level takes us back to the heady days of June 2015 and then to Q1 2015 when we saw record lows for IG spreads (B+94bp by the way). We’re not suggesting that those record tights will be revisited, but we’re just a basis point away from crossing a line into ‘bull-territory’. With the primary markets likely to awaken from their multi-week earnings/Easter/election slumber this week, we might see a cap on any material near-term tightening in the cash market.

€750m deal: Spanish banking group Banco Sabadell

In just five sessions in May, the high yield index has tightened by 20bp to B+330bp, admittedly with just one deal through it. That’s a stunning 85bp tighter this year alone, leaving the index to return 3.1%! In a year when fixed income returns are meant to be low/struggling amid weakness in government bonds into an economic recovery, the corporate bond markets are currently performing very well.

Demand has always been extremely robust. Another 9bp of tightening gone the index takes us to levels seen in June 2014 (B+321bp) – and after that, we will be at 10-year tights for this index. It’s not as if we haven’t had much supply, because we have. At the current rate, which has seen €22.7bn of issuance (including last week’s deal from Norican), we’re heading for a record year for euro-denominated issuance in HY.

The BoE completes its QE corporate bond purchase programme and sterling spreads have a good week on the follow! Spreads on the index were 3bp tighter to G+144bp and at the post-Brexit euphoric levels, but there is a way to go before we get to multi-year lows (G+132bp).

Last week still failed to show many signs of life with a couple of shorter-dated floaters (GM/Daimler) and a sub-benchmark issue (Brisa) being all that the non-financial IG market delivered. Banco Sabadell‘s €750m AT1 offering was perhaps the most interesting and pick of the bunch. in High yield, we just had €340m from Norican.

All that is about to change. There is little stopping us now, except perhaps for a few corporates which might still be in blackout, but we do need somewhere of the order of €25-30bn of new deals to go someway in correcting the poor supply since the beginning of April (€7.4bn).

And macro helps

The markets this week will open on the front foot following relief of that solid Macron election success. The US earnings season starts to wind down with just under 50 S&P companies reporting, the BOE meets – and is expected to signal no change in policy, while US inflation, retail sales data and several Fed speakers will keep us occupied from the US.

The headline number of US jobs added in April of 210,000 was an encouraging one, as was the lower unemployment rate (dropped to 4.4% from 4.5%). However, the growth in hourly earnings dropped to 2.5% year-on-year and probably would have been enough to keep the Fed on hold at the June FOMC meeting. However, we would think that with labour market conditions looking fairly robust, they will raise rates as the hawks get their way. US equities were in good shape, with the S&P closing at a record high of 2,399.

Equities should follow suit in Europe and while government bond yields have backed up (OATs apart), credit will take its cue from the broad risk-on sentiment with iTraxx protection levels likely to fall some more and cash spreads to retain their better bid of late.

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.