1st March 2020

📉 The Black Swans Amass

iTraxx Main

62.2bp, +5.2bp

iTraxx X-Over

302.5bp, +45bp

🇩🇪 10 Yr Bund

-0.60%, -5bp

iBoxx Corp IG

B+126bp, +11bp

iBoxx Corp HY

B+438bp, +40bp

🇺🇸 10 Yr US T-Bond

1.16%, -14bp

🇬🇧 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″]

As the fat lady sings…

The Dax -10.3%, FTSE -12.7%, S&P500 -8.5% and the Dow -11.2%. IG euro-denominated credit (iBoxx) total returns +0.8% (spreads +23bp), AT1 index -0.9% (+85bp), HY -1.8% (+90bp) and Eurozone rates +3.0%. All after the first two months of 2020.

Tempting as it might be, we won’t be bottom fishing yet. Keep portfolios in self-isolation.

Covid-19 will not react to lower interest rates, but interest rate cuts are coming as the standard policy response. Dare we think that the EU allows members some sort of fiscal profligacy as it thinks outside of the Maastricht strait-jacket policies?

We are staring into the abyss and we need some unorthodoxy. Whether it’s all over – ten years after the start of the financial crisis – is probably still open to question. The authorities’ ability to contain and control the outbreak and the longevity of it will determine the extent of the economic carnage.

Orthodox central bank action did a fantastic job in getting us this far during the last post financial crisis decade. And while more of it will come, it’s not going to save macro if the virus’ spread continues on this current savage trajectory.

The black swans are amassing on the horizon and we have our much-feared ‘cliff-risk’ event. Witness the weekend’s Chinese manufacturing PMI for February, crashing to well-below expectations, to just 35.7!

We’d hang our hats on there being a broad shift now in the structure of the macro economy. The world will pull in its horns. Globalisation as we know it will most likely endure a major multi-year structural change and the complex globally integrated global supply chains might have changed for a generation.

Growth will be slashed; Economic recession it is. Corporates earnings will be savaged and investment pulled back. New strategies for a whole host of industries will be put in place such that recovery will be laboured when it eventually comes (after an initial catch-up surge).

So it’s been a horrible end to the month. Equities have corrected sharply, losing over 10% in a week (record time) from their record highs. Rates have been so well-bid that US Treasury yields now reside at record lows in the benchmark 10-year and 30-year maturities.

With it, credit has finally succumbed and been battered. And there is no hiding place for investors who themselves will be forced to self-isolate portfolios and hope for the best. There will be an awful bid (or no bid) as there always is when ‘everyone’ potentially looks for the exit. It’s a case of “don’t call us, and we certainly won’t be calling you’.

The markets are therefore illiquid and spread marks are exaggerated. Screen prices are really no guide to where the market actually is. There’s some consolation there because we can ratchet tighter into any calm.

Unfortunately though, until equities stabilise, credit will remain under pressure. And the current level of market volatility will make sure that primary stays closed.

Performance devastation

Risk assets have taken a pounding with just one week’s worth of activity serving to cull the previous seven weeks or so of stellar gains. From having just set records in equities, to bust.

Credit markets came under immense pressure as the equity sell-off gathered steam and the extreme illiquidity of it into a sense of crisis ensured any semblance of a properly functioning market – a transparent clearing price, was lost. For the year to date, only the IG market has a positive total return, but that is no consolation with spreads 23bp wider.

The higher beta markets – where the underlying asset is more correlated to the macro outlook – have been crushed. The high yield market returns fell to -1.8% and spreads on the index have now widened by 90bp to end Feb, having gapped some 110bp in the final week of the month.

The bank AT1 market also came under immense pressure. It was up 3% in the year to mid-Feb but closed the month returning -0.9% this year. Spreads are wider by just 85bp this year, but a 130bp from the mid-Feb lows. Again, the poorest of liquidity conditions has not helped.

The longer duration IG sterling corporate bond market was ahead of the curve into the middle of February, up by over 2% but closed the opening period to end February some 2.3% in the red on index spreads only 16bp wider. The gilt rally has been more laboured than the bund one.

It’s the virus, stupid

Correction territory for stocks means that ‘big movement” lower in equities. The volatility index in the US, the Vix, spiked to 49.5% before settling lower at 40% as equities staged a fightback to close well off the session lows. The S&P ended just 0.8% down and the Dow 1.4% (-357 points having been 1000 again earlier in the session) with the Nasdaq unchanged.

Credit wasn’t spared in last week’s final session in an up the stairs, down the elevator type of trading dynamic. Of course, there’s no decent bid, with the Street in ultra-defensive mode as it no longer offers any kind of a shock absorber in times of stress. IG spreads, as measured by the iBoxx index, ratcheted 11bp wider in the final session of the month, with the index now at B+126bp.

The AT1 index (iBoxx) widened by 39bp to B+480bp and the high yield index was up at B+438bp (+40bp) thus rounding off the poorest of months for the corporate bond market in recent memory.

Primary was clearly closed. Investors were busy buying protection and that pushed iTraxx Main up to 62.2bp (+5.2bp) and X-Over some 45bp higher to 302.5bp.

As for this week, expect markets to remain on the back foot – and we can only hope for smaller declines. It won’t be pretty after seeing that weekend manufacturing PMI release from China, which highlighted the extent of the crash in manufacturing activity.

That is, February’s China’s manufacturing PMI came in at just 35.7 against expectations of 46 versus January’s 50. It will possibly improve from here, as factories reopen, but the recovery is going to be laborious and modest at best, as supply chains are disrupted elsewhere as the virus spreads.

The data from the US has manufacturing and services PMIs released for February and we close out with the non-farms (225k expected). We have a host of PMIs due from the Eurozone and the UK. CPI, PPI and unemployment in the Eurozone follow along with retail sales and services PMIs towards the end of the week.

All that matters will be the trajectory of the spread of the coronavirus. There are no bounds at the moment as we wait for the process to peak. Brace for further losses.

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.