27th March 2019

Recession fears boost corporate debt

iTraxx Main

68.5bp, +0.9bp

iTraxx X-Over

278.1bp, +2.1bp

🇩🇪 10 Yr Bund

-0.08%, -7bp

iBoxx Corp IG

B+141.1bp, +0.4bp

iBoxx Corp HY

B+447.2bp, +4.5bp

🇺🇸 10 Yr US T-Bond

2.38%, -3bp

🇬🇧 FTSE 100

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🇩🇪 DAX

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🇺🇸 S&P 500

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Q2 beckons, time to hang on…

We’re almost over the finishing line for the first quarter of 2019 and, despite some wobbles of late borne from the fear of global recession, fixed income investors will be feeling replete. These next few days will be light in terms of activity with few doing anything but hoping little changes into the weekend. All the rage as we head into Q2 will be about central bank firepower and the effectiveness of it, and which will surely come into action once it is confirmed that we are in recession.

The arsenal of the ECB, Fed and so on might not be firing blanks whence it is unleashed – as surely it will be, and it is unlikely going to elicit the same macro-supportive response it did previously. Even back then, growth struggled reach any meaningful heights while inflation has barely touched target levels. With that in mind, we can expect more money to flow into fixed income assets as investors look once again to preserve capital (with a little bit of a coupon with it).

In our simple world, higher yielding corporate bond risk CAN BE the answer to negative yields.

Put together, we must be thinking in terms of long rates dropping some more, and potentially by a considerable amount. The 10-year Bund yield currently resides at around -0.02% and is only 11bp off the record low seen back in mid 2016. Breaking to that level is going to take a couple of bad data points in the coming weeks, or something more dovish come the next round of central bank meetings (ECB April 10, for example). We’d think that more QE is coming.

Equities are going to play out in wider ranges, but we don’t expect any significant precipitous decline in stocks while they’re unlikely going shoot higher without confirmation of an injection of central bank liquidity. Mind, a poor earnings season won’t help and even then will likely limit much upside.

In credit, that means higher beta corporate bond debt prices will trade in narrow ranges, given their close directional correlation to equity markets. But the rally in the underlying government bond market will boost total returns while yield hogs will keep spread relatively supported – aka 2016-2017. It doesn’t make sense – in isolation and from a classical economic perspective – that weak growth boosts the corporate bond market, but the ability to service debt obligations, courtesy of the collapse in funding costs is a great leveller.

Thus in the IG market, some support will come from the inflows currently looking for the relative safety a fixed income asset (read corporate bonds) to park up some cash. Many issuers are taking note that there is an excellent bid for almost anything primary. In fact, for the third successive month, supply in IG non-financials has reached €27bn (March actually up at €30.7bn) and this has exceeded any expectations we harboured when making this year’s forecasts. And there’s been no ECB QE to manipulate events either.

Admittedly, we have seen some very moderate weakness of late, but given the volatility in equities and macro-related apprehensions, that weakness can be forgiven. With IG returns at around 3% and spreads tighter by 30bp in Q1, few are going to panic now. It’s performance in the bag for potentially hairier times ahead. Whether we finish the year with say 1.5% – 2% returns or 4%+ for the IG asset class come year end will depend on how the impending recession dynamic evolves.

In the sterling market, IG spreads have tightened by 27bp and total returns are up at 4.8% year to date, akin to the level of the euro-denominated high yield market. The Gilt market rally has been a boon for absolute return portfolios this quarter.

Primary still sucking up the fund inflows

All the saga unfolding in Westminster failed to put a dampener on the primary market as Total SA and RCI Banque entered the fray. Total was the pick of the deals with a PNC5 hybrid issue for €1.5bn and offering a final coupon of 1.75%, which was a massive 50bp inside the opening talk off an order book above €7.5bn.

RCI Banque was in the market with a dual tranche deal with €750m in a 4-year maturity at midswaps+90bp and a €650m 7-year transaction at midswaps+160bp. The combined books were up at €2.7bn and final pricing 15-20bp inside the opening talk.

The other borrowers of note in the session included Romania, which lifted €3bn in a 3-tranche deal in 7, 15 and 30-year maturities at midswaps+190bp, +285bp and +365bp, respectively. The combined books exceeded €7bn and final pricing 25-30bp inside the opening mumble. In addition, Montepio issued €100m of a 10NC5 Tier 2 Note priced at 10.5%, as Leaseplan issued a combined €1.35bn in a dual tranche fixed and floating deals.

Indicative votes make for an historic day

The Brexit debate – reaching some sort of crescendo with PM May addressing her party before the indicative votes on the potential options available in Parliament – all after the market’s close. The pressure is mounting and we must now be into the most crucial week (again) of May’s disastrous Premiership. It ought to have made for a quieter session and it looked to be going that way, but we had a very volatile session as broader recession fears mounted.

So as for where the market was, it whipsawed almost frantically amid signs of increased dovishness (desperation) from the central banks. Rates were better bid, then offered and then better bid amid talk that Trump’s nominee for the Federal Reserve was calling for a 50bp cut in US rates amid dovish-like tones from Draghi.

It pushed the 10-year Treasury yield to 2.36% (-5bp) before it settled off the lows at 2.38% (-3bp). That saw the 10-year Bund yield fall to an intra-day low of -0.09% (record low being -0.13%, as if a reminder was needed), while Germany’s latest 10-year sale of Bunds was sold with a negative yield (for the first time since 2016). The yield for this benchmark closed at -0.08% (-7bp) with the equivalent maturity Gilt closing to yield 1.01% (unchanged).

Equities were lost in it all. They opened slightly lower, gained up to 0.5% (in Europe) and then pushed lower as US stocks traded up to 1% lower. It didn’t help that Germany’s Infineon issued a profits warning for 2019 earnings on lower demand for the chipmaker’s products. Amazingly, European stocks closed unchanged and US equities were around 0.5%, as at the time of writing.

And some are suggesting that there is no crisis! Or that we over-egging the downside. Investors are certainly taking little chance on this, and are happy to pay the German government for the privilege of getting their hands on some longer dated debt.

So there was enough to keep investors engaged in the primary market with focus obviously on that Total deal. Nevertheless, the IG cash market edged a touch wider (noise really) with the iBoxx index left at B+141.1bp (+0.4bp), but importantly, total returns rose to a massive 3.3%! The high yield market closed with little happening, leaving the index at B+447.2bp (+5bp) and just like in IG, returns in the HY market year to date rose to an excellent 4.9% (iBoxx index).

Finally, the indices closed very slightly offered with Main at 68.5bp (+0.9bp) and X-Over at 2.1bp higher at 278.1bp.

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.

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