6th January 2019

Tell me why

iTraxx Main

88.5bp, -4.6bp

iTraxx X-Over

357.3bp, -16.2bp

🇩🇪 10 Yr Bund

0.20%, +5bp

iBoxx Corp IG

B+177.6bp, +2bp

iBoxx Corp HY

B+543bp, unchanged

🇺🇸 10 Yr US T-Bond

2.66%, +11bp

🇬🇧 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″]

It’s the economy…

With the noise associated with the opening week of any year out of the way, we can now focus properly on the near-term outlook for the markets. It was some noise, with the markets flying in the closing session, equities up by over 3% in some instances. The US jobs report was excellent and the principal driver of the rally, while there was hope in some quarters of a trade breakthrough as US-Chinese representatives are due to meet. However, we’re not sure that last week’s closing rally will have done much to have altered anyone’s view. We would not be buying into it. Still, it has likely opened the window for a few deals in credit primary as we kick off business this week. Borrowers should grasp the opportunity.

In addition, Powell’s upbeat assessment of the US economy was welcomed (it’s his job after all) and also went some way in helping to quash the downward spiral in sentiment and markets.

Macro is going to dominate for the moment though. Even if the Fed’s Powell suggests otherwise, industrial data from the US suggests all is not well (labour market aside) as the corporate sector and the economy overall feel the heat of a slowdown, and adds to the gloomy data before it from China. The Chinese have reacted by reducing their banks’ reserve requirement (again) and it also might have added lift spirits – but only temporarily. We think they’re pushing against a string.

The next round of central bank meetings is going to be very interesting. The Fed is being challenged and will need to reveal a more dovish stance – It at least has a job on its hands with the labour market so robust amid weakness elsewhere, the ECB likewise. We think that it is quite obvious that we are into the beginnings of what could be a significant downturn and the armoury with which central bankers have to tackle it is going to have a less punchy impact than it once might have had.

So we are needing to batten down the hatches for a while. It’s difficult to see how risk can rally meaningfully and sustainably from here. Equities will remain volatile and most likely go lower, rates will remain rangebound at these lower yield levels and maybe they will trend lower depending on the prevailing news flow. We think that they will, and look for the Bund yield to see 0.10% soon.

Credit is in a quandary of its own. The default rate is going to rise, but still be at very low levels – and low levels versus where are (or might be) in the current economic cycle. Corporates will rein in spending and preserve cash and balance sheet integrity. Issuance will decline this year versus even the low level we had in 2018.  Single name event risk might rise, and those issuers will be punished severely as we saw in 2018.

The new issue market will be receptive to deals when it can (now is a good time) but it won’t be exciting, while new offerings will need to print with significant concessions. Thus we expect repricing of secondary markets and spreads weakness during the next period (of a few weeks). Underlying yields are low but we think, for the moment, few will look to add much corporate risk – or even much ‘safe’ corporate risk. Business-wise, January threatens to be dull.

Clutching at straws

The unemployment rate came in at 3.9% in the US versus expectations of 3.7%, just as non-farm payrolls smashed expectations with 312k of job additions in December versus the 178k expected. Wage growth picked up, too, increasing 3.2% year-on-year. Risk markets rallied and safe-havens sold off… hard.

The US trade delegation is in Beijing Monday and Tuesday, and both sides have plenty of skin in the game meaning that some sort of agreement probably needs to made to ensure that Friday’s rally isn’t a one-off.

The good news is that equities are in the black for the year! It’s been a while since we have been able to say that. A drop of over 2% has been reversed to gains of little over 1% in the S&P in just two sessions. The Dax has been more impressive, up by over 2% as we enter week two of 2019. Small mercies.

We have also had some quite big moves in rate markets. The 10-year Bund yield has been as low as 0.15% after a 10bp drop in just two sessions before it backed up to 0.21% to close last week. We are still thinking in terms of it reaching 0.10% (perhaps lower) over the coming weeks. The 10-year US benchmark has been equally as volatile, dropping from a yield of 2.70% as we opened for business this year to 2.55%, before an 11bp back up to close at 2.67%. With the Fed possibly needing to exhibit a more dovish tone, it appears that anything north of a 2.80% yield on the 10-year is going to be difficult.

Credit primary delivered more than we might have expected, given the background noise. We had two deals from the auto sector (Toyota and RCI Banque) for €1.25bn in IG non-financials, but the rest of the flow took in a plethora of covered bond issues and SSA issuance. The high yield market is going to be shut for a while until such a time we achieve a semblance of stability and calm in equities as well as a return of confidence.

Because IG cash continued to leak wider even as equities rallied on Friday. The IG cash iBoxx index moved another 2bp higher to B+177.6bp (+5bp already this year), although higher beta credit managed only to close unchanged. The HY index was left at B+543bp while the CoCo index was at B+738bp (+30bp last week).

The synthetic indices are taking their cue from equities. iTraxx Main closed at 88.5bp which was some 4.6bp lower in last week’s closing session, while X-Over was 16.2bp lower at 357.3bp. This close correlation will continue between CDS/equity.

This week kicks off with us waiting for news on those US-Chinese trade negotiations (Monday and Tuesday) and there is inflation data from the US which might matter, to close out the week. In the UK, MPs are back in the saddle, and we will have a week or so of Brexit headline risk, ahead of the ‘meaningful vote’ which is due sometime next week.

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.