19th March 2020

💺 That’s it, sit back and wait

iTraxx Main

118bp, -17bp

iTraxx X-Over

677bp, -23bp

🇩🇪 10 Yr Bund

-0.25%, -3bp

iBoxx Corp IG

B+247bp, +3bp

iBoxx Corp HY

B+884bp, +24bp

🇺🇸 10 Yr US T-Bond

1.07%, -19bp

🇬🇧 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″]

Time for a sober re-assessment…

They’re coming thick and fast – and with increasing regulatory. The Fed, BoE, ECB, EU, ECB and BoE again. Rate cuts, asset purchases, fiscal splurges, mantras of ‘whatever it takes’. My, whatever next, helicopter money?

For the investment grade corporate bond market, the crisis in performance for investors probably sees a chink of light at the end of the tunnel. The ECB unleashed its buyer-of-last-resort backstop bid and this has/will go some way in assuaging the worst fears for most of this section of the corporate bond market. The central bank will absorb the outflows as nervous and/or forced sellers unload their holdings and we might have found a floor in spreads.

The very nature of their business models/ratings allows for investment grade corporates – from a credit perspective – to withstand a period of weakness in macro. There will be the obvious and well-documented casualties along the way, but the IG market will be able to get through the spring/summer economic weakness – even if macro has fallen off a cliff.

IG has reacted positively but tentatively but we’re not sure it necessarily helps the primary market establish a ‘clearing’ level for new paper. More interestingly, how will the HY market’s direction map out?

The macro pain and ongoing risks are evident. Unfortunately, the liquidity provision and the transmission mechanisms might not be sufficient to have made an early enough impact.

Clearly, Eurozone GDP growth will have collapsed in Q1 (heading towards negative high single-digit declines?), and it won’t look any prettier in Q2. With any luck, the economic weakness is not prolonged, mostly contained to H1 and a U-shaped recovery can be engineered at best. It won’t be a V-shaped return to health.

The ECB might now be buying up a considerable swathe of the IG market (it already holds a share under €200bn of it), but will they force (as they crowd out) investors to increase their interest in the high yield sector? There is going to be some resistance this time.

That worked through the original QE effort which began back in 2016, less so in the subsequent ones. And right now, for investors, it isn’t about ‘how much yield can I get’, but more about ‘preserving capital’.

The last time we had spreads under severe pressure (in 2008/9) macro was busted but we had a huge easing which helped the refinancing of the sector over some exceptional years – Eurozone crisis aside in 2012. Spreads in HY (iBoxx index) might have widened to B+2000bp+ in 2009, but they clearly overshot as the default rate only rose to 13% – much less than the implied rate.

This time, we have busted macro (much worse than last time) but corporates chugging along – before the current bust, happily funding at or close to their lowest ever funding levels. The problem is the default rate. If this downturn extends into Q3/4, the the default rate will surely rise to in excess of 15%. Until we get some clear idea, do not expect much.

So, if we can get a grip on the virus (develop a vaccine quickly, flatten the peak and so on) any resumption activity allied with that massive monetary and fiscal boost has us with a great chance of a V-shaped recovery. That ‘saves’ the market.

BoE is all-in

The BoE went in early, hard and big, cutting rates to 0.1% (and its lower bound) which necessitated the additional QE (of £200bn) – and the UK government has its funder (investor for its massive debt splurge).

UK rates were heading higher before the move but we saw them retrace their losses with a decent gain at the front end. The 10-year Gilt yield was eventually lower at 0.64% after a late rally (having been up at 1.05% at one stage).

Bund yields were flattish, coming after some wild swings of between -0.38% and -0.14% before closed out to yield -0.25%, with the equivalent Treasury yield at 1.07% (-19bp) later into the US session. While those markets were trying to find their feet, the much-tarnished Italian market found a good bid, recovering to 1.70%, representing a decline of 61bp for the yield on the 10-year BTP.

And the equity reaction came, but not until after much hesitation and thought. It wasn’t great. After being down almost 3%, the surprise rate/QE moves saw them rise by 1.4% at the close, but that come courtesy of a very late rally.

The Dax was up 2% after also spending most of the session in the red, with US markets dipping in and out of the red/black before themselves being up by 1% at the close.

Mixed credit markets

So with all the concerted easing in policy rates, the fiscal splurges and QE, akin to throwing the kitchen sink at trying to limit the downside of the economic havoc caused by the spread of the coronavirus, we’re still not hitting the ball out of the park. The initial market reactions suggest as much.

In credit, our thoughts on IG/HY markets seemed to have played out in the synthetic indices with iTraxx Main 17bp lower at 118bp and X-Over only 23bp lower at 677bp. the ratio between them jumped to 5.7x.

The cash market got some much needed respite from the recent turmoil which had battered it. The investment grade market was just 3bp wider leaving the iBoxx index at B+247bp (versus 15bp in the previous session). Even the AT1 market got through relatively unscathed, with the index eft at a B+1506bp (+7bp and noise in the big scheme!).

Alas, the big loser was the high yield market, with spreads on the index widening to B+883bp (+24bp) with returns year to date declining to -19.2%.

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.