6th December 2018

Stormy… waters

iTraxx Main

87.8bp, +5.6bp

iTraxx X-Over

350.5bp, +20bp

🇩🇪 10 Yr Bund

0.23%, -4bp

iBoxx Corp IG

B+175bp, +2.5bp

iBoxx Corp HY

B+520bp, +11bp

🇺🇸 10 Yr US T-Bond

2.87%, -5bp

🇬🇧 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″]

Donning tin hats…

Oh dear! The arrest of Huawei’s CFO takes us into a whole new ball game. It’s no longer just macro we need to worry about (in the trade spat between the US and China), but geopolitics now too.

China won’t look favourably on Meng Wanzhou’s arrest in Canada

China will respond. News of that overnight arrest in Canada took equities in Europe lower by around 3%, the S&P was back in the red for 2018, it necessitated a bid for safe havens that pushed 10-year Bund yields to below 0.25%, and made for yet another session in which credit spreads moved wider. Primary was closed. The nail in the coffin for December would be a heavy defeat for Theresa May’s Brexit plan in Parliament next week.

So the path of least resistance is lower (for equities), wider (for credit spread) and lower (for government bond yields). Mostly rather unfortunate and, in hindsight, the wheels on the bus have been coming off since the back end of Q3. After such a hopeful, aggressive rally in the opening session of this month, it now appears as though December is going to be the most difficult of months.

Credit investors are, for sure, feeling some considerable pain at the moment. On reflection, we would concede that it was probably to be expected given the rumblings and volatile situations around macro and geopolitics.

It doesn’t look like much is going to change into the start of next year (at least) with Brexit, Sino-US trade tariff talks/skirmishes and even the Italian/EC spat on the 2019 budgetary proposals set to drag on.

So we are likely going to close 2018 on the back foot, nursing some considerable losses (relatively) in all risk asset classes. Into quieter climes – as December usually brings – there is, therefore, a good chance that with the lower levels of investor participation, markets will react disproportionately – meaning exaggerated reactions to the prevailing news flow, which will likely be negative.

The damning detail of the Attorney General’s advice to the government on the Brexit Northern Ireland backstop leaves us with the non-trivial probability of not just a defeat on Theresa May’s proposal next Tuesday but for a new PM in place soon enough, too. The size of any defeat will determine whether (if/when) May falls on her sword. The net effect should be that there ought to be much concern in EU circles. When taking in the growing populist movements across Europe (the French gilet jaunes protests too), then it leaves much to reflect on for 2019.

Defensiveness is going to be the key. Even the once great Deutsche Bank’s situation looks precarious. The US 2s/5s yield curve has inverted, and the 2s/10s has just 15bp to go (was 10bp). Moves towards tighter policy are going to have to be reined in. The Fed will have taken note and recent comments have been less hawkish. the same goes for the ECB. We don’t think they will change anything on their QE stance (it concludes at year-end), but Draghi is going to have to retain other policy accommodation way past the summer of 2019. Any additional measures will depend on the Eurozone’s macro developments as the new year progresses.

After a rise of 2% on Monday, the Dax is in negative territory for the month – and by a large margin. As if a drop of around 13% year to end November wasn’t enough, it is now over 16% lower YTD! The 10-year Bund yield is back at well below 0.30%, representing a real poke in the eye for the majority of rate forecasters who looked for 0.75% – 1.00% by year-end. Credit had done well with IG total returns holding at above -1% for most of the year but was giving up in November as spreads gapped, and we continue to lose performance in December. Year to date, IG credit returns are at -1.6%, with spreads over 7-bp wider (iBoxx index).

Scraping the barrel in primary

In calmer climes, some might be looking around for potential borrowers as the market activity starts to wane. We’re a little thin on the ground for deals, but it’s December and we did have the surprising €4.5bn SAP offering already this week. Since 2014, for example, the highest amount of issuance in December was €9.3bn (2014) and just €1.6bn, €3.1bn and €6.75bn in the three years since.

So if the recently completed roadshow from Emerson Electric leads to the touted dual tranche deal then we’re already ahead of at the curve – and might just whip past the €10bn mark before we close for business by the end of next week. It is unlikely. Furthermore, it probably won’t be a bad thing – or isn’t a bad thing – if we do get very little deal flow. It’s not as if primary deals on the break have been performing.

It’s going to be choppy so borrowers will need to pick their moments. The Brexit vote will disrupt markets on Tuesday/Wednesday next week, while the non-farm payroll report and Thursday’s massive sell-off will have made sure we have concluded any primary business in corporates for this week.

That means we might be stuck with around €220bn – €225bn of issuance for the full year in IG non-financials, not much more than the current €62bn on high yield and we can’t be looking at much in senior financials (€130bn now) given the flattening of yield curves and poorer news flow around the sector.

Fear stalks the markets

So it feels like we have fallen off the edge of a cliff. It’s been an awful year for risk assets. Unfortunately, as suggested above, we can’t hope for it to be too much better as we cross into 2019. Many of the situations that we are grappling with now will still be with us in the new year.

Trump: Oil price where he wants it

As well as the Dax falling by 3.5% in the session (other bourses with similar magnitude) oil took another tumble with Brent off by over 3% and back below $60 per barrel, as talk surfaced that production cuts would fall short of expectations. Trump will be delighted.

Duration caught the expected strong bid, pushing the 10-year Bund yield 4bp lower to 0.23% at the close while the equivalent maturity Gilt was yielding 1.24% (-8bp). It was less than three months ago that Bund yields in that maturity were up at 0.58% (Q1 2018 high of 0.80%) and started the year with a yield of 0.42%. The high point for the 10-year Gilt yield was 1.75% a couple or so months ago. US Treasuries were similarly massively in demand, thus pushing the 10-year yield down to 2.87% (-5bp).

Almost alone to suffer was Italian government bond risk, the 10-year BTP yield rising to 3.21% (+14bp) as any demand for it faded on the back of obvious concerns about the budget, but also the €3.2bn tap of the 21s.

In credit, high yield issuer Vue pulled back from a potential deal, while US corporate Emerson Electric also did a no-show. That was always going to be the case given the severe weakness in risk markets. Secondary credit was very weak again. Investors had no choice but to sit on their hands and watch it all happen.

In the synthetic space, CDS was aggressively bid (higher) as a sense of panic took hold. It pushed iTraxx Main 5.6bp higher to 87.8bp with a 20bp rise in the X-Over index to 350.5bp.

The IG iBoxx cash index widened by 2.5bp to B+175bp and the high yield index took a 11bp hit, to close at B+520bp. Cash credit is feeling the pain.

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.