27th February 2019

Show me the risk!

iTraxx Main

61.5bp, -1.2bp

iTraxx X-Over

273.9bp, -2.6bp

🇩🇪 10 Yr Bund

0.15%, +4bp

iBoxx Corp IG

B+146.5bp, -2.25bp

iBoxx Corp HY

B+451.5bp, -5bp

🇺🇸 10 Yr US T-Bond

2.68%, +4bp

🇬🇧 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″]

Markets’ buoyant February…

We’ve thrown all caution to the wind in these opening couple of months of the year – and it feels great. All asset classes have been on the up. The risk-on mood in the market has had equities push higher, credit spreads have ratcheted tighter and commodities have the wind in their sails. On the flip side – and classically it should not be the case, government bond market investors have also had a very good time out.

It means that we have plenty of performance in the bag, which we are going to need. Because recession risks loom amid the current slowdown, and dislocations in the aforementioned performances are going to come. However, in credit, is this 2009, 2014 or 2016 all over again? Or is central bank profligacy a busted flush as we try to contain the decade long build up of (debt) excesses with reduced effective firepower?

Equities have been in the ascendancy on hopes of a trade deal between the US and China, while anticipating only a moderate slowdown in macro and buoyed by hopes that further policy rate increases might be avoided completely this year (in the US). The S&P has gained over 11% this year. The Dax is up by around 8% while the FTSE’s gains exceed 5%.

Credit is supported by the same issues but the hunt for yield makes it feel like we’re in a ‘back to the future’-like zone and the demand periods seen in the 2008 – 2018 period. Low rates, potentially a Goldilocks-like growth dynamic and low default rates keeps spread markets better bid with some excellent performances derived from it.

Previously, the corporate bond market sailed through the Eurozone crisis albeit having to manoeuvre through a difficult period which had locked peripheral borrowers out if the market for a year or so. The default rate barely rose above 3% at any time since 2009, though. We traded through a recession and a few periods of extended low/no growth and came out the other side in good shape, but fretting about whether credit had had its day. And questioning several times whether investors would rotate away from the defensiveness of fixed income to preserve capital to chase growth in equities? We’re still asking the same questions and playing the same game – but chasing yield.

There are some understandable nerves which keep duration better bid. The 10-year Bund yield ought not to have resided at a paltry 0.10% if all was good on macro. Cliff risk is being discounted as are a whole host of other risks but the market has chosen to swat them all away. Risk markets are just going for it, knowing that that markets ‘cold turkey’ moment isn’t going to come just yet. No one can afford that. Central bank firepower will keep pushing against that string, while the effectiveness of another bout of easing will likely diminish.

So it’s all in the timing. We’re never going to get that right. Meantime, the debt bubble builds.  So right now, risk is your friend. We have clipped plenty of performance and we dare say there should be more to go which will see out the first quarter as a very good one.

For instance, IG spreads have tightened by some 25bp (iBoxx) and total returns are up at 1.9% YTD. Meanwhile, high yield spreads have tightened by 65bp and returns here have delivered 3.9% in the year to date. We might have had Santander miss an AT1 call, but yield (or greed or whatever one wants to call it) hasn’t impacted the lure for CoCo risk. After all, KBC got a deal away this week paying just 4.75% for it (€500m) and the sector has returned 4.8% YTD and spreads are 122bp tighter so far this year.

Rare reversal in fortunes for some

We had a weaker session on Wednesday as we trotted the same old excuses for the weakness – previously ignored – such as geopolitical tension (India/Pakistan into the fold now), while we awaited news of the US/North Korean summit. Normally, we might have expected a move higher after the Fed’s Powell reiterated the central bank’s patience stance on rates overnight. But all that means is that macro is looking precariously placed right now.

Anyway, it was a rare weaker session – for all markets and in direct reversal to the discussion above! It didn’t help that Powell’s second day of testimony to the House had him suggest that a plan to complete the process of reducing the Fed’s multi-trillion balance sheet would be announced soon. In effect, a de facto tightening in policy.

Rates moved sharply higher leaving the Bund yield in the 10-year up at 0.15% (+4bp), the Gilt up at a yield of 1.28% (+7bp) and US Treasuries in the 10-year at 2.68% (+4bp). The European Commission was busy warning of excessive imbalances within the Italian economies as the sovereign’s debt load increases, and this saw a slight move higher in yields (the 10-year up at 2.77%, +7bp). There’s much more to run on this particular story.

In equities, European equities closed off the session lows leaving the Dax 0.5% lower, the FTSE down by 0.6% while US markets were up to 0.4% lower as at the time of writing.

The credit market managed to eke out a few deals. In the corporate sector, IG non-financials were represented by yet another US domiciled borrower as Paccar Finance issued a €300m, 3-year maturity transaction at midswaps+25bp, which was -25bp versus IPT off a €1.9bn book, thereby maintaining the current form in demand for corporate debt. Senior financials delivered Bankinter’s €500m offering in a 5-year at midswaps+75bp (IPT -20bp).

IG Issuance

As illustrated above, following a rousing near €27bn of IG non-financial issuance in January, we’ve had €25.7bn in February and way in excess of our expectations. The almost €53bn in these opening two months might not be a sustainable rate, but the deals have been taken down well amid a broad confidence in risk markets.

In secondary cash, we had the customary quieter session, but we continued to squeeze. Spreads as measured by the cash IG iBoxx index tightened by 2.5bp and was left at B+146.5bp. Unfazed by the potential for any risk, the tightening in spreads was seen across the board and the squeeze was felt in higher beta markets as well, leaving the HY index at B+451bp (-7bp).

For the indices, we moved a little tighter again with Main at 61.5bp (-1.2bp) and this index is 27bp tighter this year now. X-Over protection costs also dropped and we closed at 273.9bp (-2.6bp) leaving the index around 80bp lower in 2019.

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.