22nd June 2016

The day after the night before

FTSE 100
6,227, +23
10,016, +54
S&P 500
2,089, +6
iTraxx Main
79bp, +1bp
iTraxx X-Over Index
341bp, +1bp
10 Yr Bund
0.5%, -1bp
iBoxx Corp IG
B+145.6bp, -1bp 
iBoxx Corp HY Index
B+495bp, +-3bp
10 Yr US T-Bond
1.68%, +1bp

Not quite a hangover…

Following the euphoric session on Monday came the typical market response on Tuesday. It would appear that the shorts have been covered, the apprehensions alleviated and should Remain now succeed in the referendum campaign – as the market expects and the polls suggest, then Friday’s reaction will possibly not be as great as Monday’s. britainApart from the modicum of excitement it might generate in some quarters about it being business as usual, there’s no reason for the market to rally super hard. Certainly in Tuesday’s session that was the case where a tentative session left the only noticeable rally in parts of the corporate bond market. That was mainly in HY. There were not the sorts of volumes one would expect to be going through as spreads gapped wider last week, nor did we see any major uptick in volumes as they recovered hard in the session yesterday. It was a catch-up moment with the Street tightening up the market into every enquiry.

Primary drew another blank across the board. We’re not quite sure why that should be the case as deals would be met with a very good reception if a borrower decided to print. The fear around not getting a deal away easily enough pre-referendum is unnecessary. Christian Dior got a tremendous reception on Monday, for example. The lull in primary therefore is a little disconcerting given that July and August beckon and traditionally we see issuance in these months as very light. On the other hand, if indeed the current reduced levels of supply are due to Brexit fears, then we could expect a busy period from next week into the middle of July as borrowers get any delayed funding in before the holiday season starts.

Credit set to record a stellar first half

The ECB has almost assured performance of the corporate bond market for this year given its recent involvement in it. The evidence is in the volatility besetting other asset classes which we have avoided given the remarkable scale of the buying activity they have embarked on. Having lifted €2.25bn in six sessions from June 8, investors are soon going to feel the frustrations that come with being elbowed aside by the central bank. Allocations in primary will suffer, secondary market liquidity will wane further, and hitherto thought of as being rich corporate bond levels are going to get richer. But performance wise, 2016 ought to be excellent. Given where we started the year and how those opening two months panned out, the corporate bond market has had a good time of it since.

IG total returns of 3.5% YTD are excellent and have only visited negative territory for a short period during those opening months. Benchmark players have had a tougher time of it, but are going to be big out-performers too given the generally higher beta nature of most portfolios. In HY, performance has been more volatile which is understandable given the closer correlation of the asset class to equities, but also from the lack of direct support from a central bank! Returns as measured through the Markit iBoxx index are also up at around 3.6% YTD, but we did see -2.5% in February. The asset class still has some lure and continues to benefit from low rates, yields and a crowding out impact from ECB buying in IG that will see investors needing to add greater levels of HY risk.

To-ing and fro-ing soon to end

It will be all over by the weekend, and we can then focus on fundamentals of the global economy as the chief driver of performance for the rest of this year. Assuming, of course, we vote to remain in the EU – and we will use this as our base case scenario.

Some of the latest business surveys suggest a better tone in terms of sentiment, but they have been impacted by the Brexit situation, and therefore offer little new insight about the state of the macro environment. We still think it will blow a little colder through the end of this year and expect additional policy action in due course as a result. Yellen’s Senate Committee statement yesterday was also very cautious and measured and feeds into our own view that the outlook holds considerable risks. She certainly dampened spirits.

We still believe that the 10-year Bund yield will revisit negative territory again and stay there for longer than it did recently. That is, it will be more than just a passing visit. Others will follow lower, but not always necessarily into negative territory. Gilts look like they might have seen their lows and only go back into record-breaking mode if the Leave camp wins the referendum vote.

So we closed out on a slightly better note, having been through mostly a dull session. Equities were a small up, yields in government bonds slightly lower while oil prices were choppy on conflicting Nigerian ceasefire reports leaving Brent trading around $50 per barrel.

In credit, a light session saw spreads edge better again such that the Markit iBoxx index was down at B+145.6bp and the index yield dropped to 1.22%. We’re still targeting 1% for the latter and B+100bp for the index spread – by year-end. As for the high yield market, spreads also tightened and that left the index at B+495bp (-3bp). The iTraxx indices had a more circumspect session, actually a touch wider to essentially unchanged. Main was left at 79bp and X-Over at 341bp.

On a housekeeping note, this is my last note for a week – as I need a holiday! I will be back on July 1 with a resumption of the daily, although if the UK votes to leave the EU, I will get something out on Friday.

Have a good week.

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.