4th February 2018

The Great Tempest

iTraxx Main

45.2bp, +1.3bp

iTraxx X-Over

248.7bp, +8.3bp

10 Yr Bund

0.76%, +5bp

iBoxx Corp IG

B+82bp, -0.8bp

iBoxx Corp HY

B+274.6bp, +1.3bp

10 Yr US T-Bond

2.84%, +7bp

FTSE 100 [wp_live_scraper id=”4″], [wp_live_scraper id=”5″] DAX [wp_live_scraper id=”12″], [wp_live_scraper id=”13″] S&P 500 [wp_live_scraper id=”10″], [wp_live_scraper id=”11″]

Or an opportunity to buy the dip…

The rate market rout continues, and it is taking in equities now, too. The Dax is now back in negative territory year to date. From boom for most of January to a feeling of bust for the foreseeable future as the ‘fragile’ positive tone of the market has flipped completely. ‘666″ is indeed the number of the beast, the Dow dropped by that much on Friday. Is it as unexpected as it might seem? After all, it was always a case of ‘be careful what you wish for’. Policy makers have spent the ten post-crisis years trying to engender a sustainable economic recovery. And it looks like they have it as macro is as solid as we might expect even if odd data points miss expectations.

And that macro recovery is the principal driving force for the markets current woes. Rates have reacted and sold off into an eventual normalisation of policy – however long that might take. Only the most bearish of rate market predictions for the year are yet to be met. It’s been some recoil over the last couple of weeks.

FX markets have also reacted. The euro is strengthening (not helped by US policy makers talking down the dollar) and that will have an impact on earnings in translation, as well as the relative attractiveness of Eurozone stocks.

Corporate creditworthiness usually improves into improving macro. Spreads usually go tighter. That’s happening now as spreads go deeper into record territory. The secondary impact is yet to come.  That is, the positioning or relative attractiveness of credit versus equity risk. By all accounts, money is still flowing into IG corporate bond funds, so that rotation trade is still some way away. It may not even come!

So corporate credit fundamentals are improving, spreads are tightening, the ECB is buying, debt financed M&A is still very far away from savaging the sector as it has done many a previous cycle, and we’re not exhibiting anywhere like the level of volatility impacting other markets (Bitcoin is 40% lower this year, another example). We would suppose that as long as we have the jitters affecting equities, then few will look to sell credit and add equities. The big question is rates and how they might go before the income there is more attractive than being in credit?

In reality little might have changed fundamentally but, of course, market turning points are notoriously hard to define, and much easier retrospectively. We think events will soon unravel and become more coherent. After all, the 10-year Bund has risen from 0.42% to 0.76% this year and the 10-year Treasury from 2.40% to 2.84%, while equities in Europe are dropping (Dax -1.1% this year) – but in the US they’re still in the money even after those massive falls last week (Dow +3.2%, S&P +3.3%). And all that given expectations are for the US hikes, but a slow taper and no hikes in Europe until 2019!

+200k and 2.9% – Ouch

They’re bond market unfriendly numbers. Especially that 2.9% wage inflation number. And that meant a hit for stocks as rates sold-off. US non-farm jobs added 200k in January, but more importantly, wage growth accelerated to 2.9% year-on-year to their fast level in almost a decade. Immediately, the market was sharpening its pencil for more than the expected three rate hikes in the US this year.

Rates markets received a savaging and later in the session, equities did too! The 10-year US Treasury yield rose to 2.84% (+7bp), the same maturity Bund yield to 0.76% (+5bp) and the 10-year Gilt yield to 1.59% (+6bp). And US stocks took another hit, this time down by up to 2.5% in the session (Dow).

We’re likely going to see a further negative reaction as we open on Monday as the big US falls came after the close in Europe, but there will be an element of buying the dip which ought to limit the downside.

Credit rock solid, for now

So, we closed last week a little shell-shocked. Interestingly, the non-farms didn’t necessarily close the primary credit markets and a couple deals did get away. One of AB InBev’s investors Bevco Lux, which is controlled by Colombia’s richest family, issued €800m in a 5 year deal priced at midswaps+140bp (-1bp versus IPT) and managed to get interest of €2bn. The other deal of note was Volkswagen‘s foray into the sterling market for £300m at G+75bp in a 4.5-year maturity.

As for the rest, the focus was obviously on equities and rates, but credit reacted with Main higher at 45.2bp (+1.3bp) and X-Over rising by 8.3bp to 248.7bp. There won’t be too many rushing in at the open to sell protection (add risk) and we would think a cautious tone before the US markets open later.

The move in the stock markets didn’t derail IG secondary cash, though that has to come Monday or sometime this week if the stock and rate market rout continues. Spreads actually closed a little tighter in last week’s final session, and the IG iBoxx cash index closed at a fresh record tight of B+82bp (-0.8bp). That’s 2.5bp tighter last week and 14bp tighter this year already. We would suppose there is some safety in this market but weakness elsewhere will weigh soon.

The CoCo bond market saw some weakness, although again, it was fairly modest. The iBoxx index only edged 5bp higher to B+311bp – although that is 23bp off the record tights in a week, but still 55bp tighter for this year. And total returns are still easily in the black! In the high yield market, the index moved just 1.3bp higher to 274.6bp. Should equities move lower in this week’s opening session, we can expect a more aggressive defensive mark on paper by the Street as the bid suddenly disappears. Primary will be quiet.

We’re thinking that the default position of the market will be that this current weakness will blow over soon enough. Let’s see.

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.