19th September 2016

It’s showtime

FTSE 100
6,710, -20
10,276, -155
S&P 500
2,139, -8
iTraxx Main
71.5bp, +1bp
iTraxx X-Over Index
336bp, +4bp
10 Yr Bund
0.00%, -2.5bp
iBoxx Corp IG
B+122bp, +1.5bp 
iBoxx Corp HY Index
B+443bp, +5bp
10 Yr US T-Bond
1.69%, unchnaged

Government bonds to de-correlate

The fuss around government bond yields going to the moon is proving (as we suggested it would throughout the whole of last week) to be short-lived. The Bund yield stared at a mighty +0.10% at one stage and was written off, such that the bond bubble had burst. We have suggested it will see -0.20% before it sees +0.20% and we still think that. By the way, it was back in negative territory briefly at -0.02%, some 5bp lower on Friday alone before closing out at 0.00%.

We also think that there is much potential for the continuation of the de-correlation trend between what happens in US Treasuries versus Eurozone government bond debt. If the Fed does “surprise” and raise rates this week, all yields will go higher but we would think Eurozone government bonds will subsequently recover more of their losses.

Technicals arising from the ECB’s ongoing bond grab, allied the with fundamentals of a still difficult economic environment means that we are in low/negative yield territory for a good while yet. The data in Europe continues to flatter to deceive (manufacturing, industrial production, wage growth, inflation and so on) and we have various situations ongoing and/or developing in, say, Italy (referendum) and Portugal (already dire public finances worsening) for instance. Brexit uncertainties linger too. Generally, we’re still in the throes of a prolonged slump. Why should policy reverse? We don’t think yields can go much higher in sustainable fashion than they did in the past week.

Could we see 10-year Treasuries at 1.9% or even 2% and the equivalent Bund yield less that +0.20%? Yes, we can. We could even see US Treasuries at 1.9% and Bunds around zero or negative yielding too. Why not? the situations in the two regions are completely different. Apart from an immediate panic-led contagion impact, should the US raise rates, there will be no lasting impact on Eurozone government bond directionality from near-term US interest rate policy.

Equities pressured by banking sector


The US DoJ wants $14bn from Deutsche Bank

Energy stocks also took bit of a hit into the close, with oil down and trading off a $45 per barrel handle (Brent).

The big news, though, was that the US Department of Justice has proposed a $14bn fine on Deutsche Bank to settle allegations arising from the mis-selling of mortgages. This spooked equities and they fell by 1% or more across the board. The beleaguered German lender saw its equity price down by around 9% with the impact of the news story seeing its AT1/CoCo debt also under pressure with the shorter call 6% issue trading off a €78-handle, around €5 lower in the session but still off the lows seen earlier this year (€69, back in that dark period in Q1).

We think that equities are likely going to stay volatile into the FOMC and will probably stay volatile for a session or two after it, as the markets try to figure out when the next move might come should the Fed decide to hold steady in this meeting. Either way, we don’t think there is an overly huge amount of downside to stocks from here. We remain positive for equities and would expect them to recover their poise at some stage next week. It’s worth noting that the DAX, though, has had a rollercoaster time of it of late – and having managed just one session in the black all year – is now back in deficit to the tune of almost 500 points in 2016.

Credit markets still pick of the bunch

The ECB might be plundering the corporate bond market in Europe, but it is not immune to some of the weakness impacting other asset classes. That spread weakness is much more measured though, and prone to a sharp reversal given the disproportionate impact liquidity (or the lack of it) has on pricing direction. So, IG spreads – as measured by the Markit iBoxx index as our broad indicator for market moves, widened by 1.5bp at the end of last week, and by some 5bp for the week as a whole. That’s not great, but the activity/flow/volumes flow behind the moves doesn’t warrant that kind of negative attention. We have the latest publication of the ECB’s purchases this afternoon. The corporate bond sector asset purchases by the ECB saw a massive lift of €2.4bn the week before last. It was only the second time they have exceeded €2bn in any given week and was just €250m short of the record.

Admittedly, there was pressure on the AT1 market, but it is such a small portion of the index and the contagion impact from it seemed limited with even corporate hybrids barely changed in that last session. In HY, it was a similar story, with spreads 6bp wider at the end of the last session, but some 33bp in the week and the index yield back up at 4%.

And the pick of the bunch? Sterling corporates! Even with £3bn of supply from National Grid, the sterling index weakened by only 2.5bp in the week, having barely budged on Friday while still returning a stunning 13.5% YTD – and that after a fairly significant sell-off in Gilts! Mind, that returns figure is a drop from over 17% a few weeks ago.

We had €8.55bn of IG non-financial issuance last week, following €10.5bn the week before. That leaves us at €19bn this month so far and a hefty pipeline of deals in the works. We can expect a slow couple of days around the FOMC so €40bn+ for the month (which would be the third time this year) is unlikely in our view. After all, it is too much to expect €20bn or more off issuance into heightened nervousness around a Fed meeting. That’s not to say we won’t get a fair dollop of issuance and we would think somewhere in the area of €12-15bn is likely in the remaining two weeks of the month.

The big “deal” last week was around all the high yield issuance and we even had a couple of issues to close out the week which saw over €2bn get away. This market in Europe has been hit and miss in 2016, but seems to have gained some traction over the past couple of weeks with deals more frequent. That could be a harbinger of things to come into the last few months of the year.

The week ahead is all about the Fed. Have a good one. Back tomorrow.

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.