25th April 2018

Slipping and a sliding

iTraxx Main

56.4bp, +0.9bp

iTraxx X-Over

279.1bp, +3.3bp

10 Yr Bund

0.64%, +1bp

iBoxx Corp IG

B+103.1bp, +0.5bp

iBoxx Corp HY

B+315bp, +3.5bp

10 Yr US T-Bond

3.03%, +5bp

FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] S&P 500 [wp_live_scraper id=”15″], [wp_live_scraper id=”16″]

Time to believe…

Just when we thought it was safe, we snatch defeat from a rally which was just beginning to see us recover losses seen in the opening three months of the year and take us back to flat and respectable. The earnings season has been a good one thus far with more hits (as is usual) than misses, but the focus is on the US rate market. We’re over 3.0% in the benchmark 10-year yield and, having resisted the level for a few sessions, the bears are willing it to go higher. The obvious and inevitable repercussions are higher funding/refinancing costs, amid a need for future US monetary policy to reflect the delicate balance between the growth/inflation dynamic.

They will get it wrong; They always do. Policy rates will overshoot, reflecting the crude tool that they are in controlling inflation while US growth might hold up for much of this year. It’s a different story in Europe, where policy rates are not going anywhere through 2018 and the first half of 2019, but market rates edging higher and oil prices rising are going to act as a de facto monetary tightening tool.

Any continued euro-currency strength is going to be an unwelcome addition, too, and trade conflicts anywhere in the world will come back to hit the Eurozone’s export industries. It’s been a while since we had such a disjointed, non-harmonious macro outlook across US/Europe/Asia.

So it is no wonder that we are struggling to make sense of it all. We might have thought geopolitics would have been the straw that broke the markets’ back after 10 years of relative bliss, post-crisis. But the party might be nearing its end as the turning tide in the US interest rate story gives markets an almighty hangover. Hawkish US policy will necessarily mean that Eurozone policy (aka the ECB) will need to remain ultra-vigilant and most likely more dovish than hawkish.

Equities are already feeling the heat. We’re going to end the month/opening 4 months of the year in the red. There is unlikely going to be a massive rally to have us dip into the black. It’s the same in rates as the rise in yields in the US drags them higher across European markets too, and sees to it that performance here is also going to be negative for the month and likely for the year to date come month-end.

As for credit, the lack of supply and poorest of liquidity conditions in the secondary market might see us as relative outperformers. And that dynamic could keep us intact through the first half. Borrowers have been shy in coming forward in IG non-financial markets, while the high yield sector is delivering deals aplenty. In secondary, investors who reduce exposure now though could possibly have the impact of leading to a disproportionate widening in spreads given that market illiquidity.

Refinancing risks in the euro-denominated corporate markets are limited, in our view, with most corporates extending their maturity obligations over the past few years such that any wall of funding has been pushed well into the future. We think corporate-Europe can easily withstand a moderate period of no/reduced primary activity, lower growth and even higher financing rates. The default rate will not pop materially higher, that is. In addition, the record low level cost of debt financing is only going to reverse very slowly. So we should not see any panic in euro-denominated credit markets.

Primary shock!

The much awaited (and we’re not sure why) Chinese electronics company Huawei‘s deal finally came to life, although the company decided to pull the dollar tranche. Following on from the State Oil Corp of China print in dollars and euros on Tuesday, Huawei priced €500m in a 5-year at midswaps+135bp ( -15bp versus IPT) off an order book of €2bn. Then after the market close, the borrower pulled the deal! That came after reports that the US Department of Justice was investigating whether the company on possible violations of sanctions banning sales to Iran. In a way, it’s just what the struggling IG primary corporate bond market didn’t need.

The repercussions could be significant for other borrowers now (especially) from the EM space with increased investor scrutiny leading to the possibility of an even larger new issue premium required given the potential for event risk. Or they might decide in no participation in their offerings at all. And we thought EM borrowers just had US interest rate risk to worry about. The news of the investigation was at least good in terms of timing for investors who were yet to part with any cash (deal not settled). Imagine the price action. The total IG rated non-financial corporate bond issuance for the month remained unchanged at €14.45bn.

The recent prolific issuance from the real estate sector continued, with Aroundtown SA back in the market with a €500m deal in a long 8-year maturity priced at the guidance of midswaps+135bp.

The high yield market delivered a couple of borrowers with Darling Ingredients€515m 8NC3 transaction priced to yield 3.75% and Flora Food Group in for €685m also in an 8NC3 structure. So another €1.2bn was added in HY in what has been a remarkably buoyant month of deals for the sector, the total up at €8.8bn – and a €27.9bn for the year to date.

Risk assets shaken and stirred

All eyes are on the US rate market, and the 10-year benchmark reached a yield of 3.03% (+5bp) in the session. The Bund only sold off a touch, the yield on the 10-year just a basis point higher at 0.64% just as the Gilt yield managed to close unchanged at 1.54% on the 10-year. It’s all happening – but not quite in concerted fashion, and US bond prices are clearly underperforming as we might expect. The periphery is managing to hold on to its support as higher yielding Eurozone government bonds curry some favour. BTPs are yielding 1.78% (+1bp) and the 10-year Bono 1.30% (unchanged).

Equities took a tumble in Europe, some of which was a case of playing catch-up with the big losses in the US overnight. Again the Dax took most of the pain, and was the chief underperforming market as it lost well over 1% with others up to 0.8% lower in the session before everything managed to fade the worst of the losses (Dax -1%, FTSE -0.6%, for example). US stocks were dipping in an out of the red/black – just as they have been for much of this month, intraday.

The synthetic credit indices traded out with investors in a defensive mood, thus better bid and protection costs rose. iTraxx Main moved to 56.4bp (+0.9bp) while X-Over was 3.3bp higher at 279.1bp.

In the cash market, IG spreads edged wider into the equity weakness without there being anything untoward to concern anyone. It left the Markit iBoxx at B+103.1bp (+0.5bp) and the high yield index at B+315bp (+3,5bp).

Have a good day.

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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.