5th April 2020

❔The high yield market mystery

iTraxx Main

114bp, +5.5bp

iTraxx X-Over

637.5bp, +25bp

10 Yr Bund

-0.44%, unchanged

iBoxx Corp IG

B+251bp, unchanged

iBoxx Corp HY

B+775bp, unchanged

10 Yr US T-Bond

0.60%, -2bp

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″]

High yield isn’t ticking any boxes…

On the surface of it, the relatively resolute performance of the high yield market takes some explaining. The iBoxx index gapped to B+2000bp in 2008 at the height of the financial crisis. This time, we barely saw B+900bp at the peak of the panic just over a week ago. That was a commendable effort.

Over a decade ago, the high yield market in Europe was under €50bn in size (might explain the huge widening – a fledgeling and illiquid sector) whereas this time it is now circa €350bn in size (no longer an immature market but still illiquid). Performance-wise, though, HY lost almost 40% in 2008 while in Q1 this year the index lost over 15% in total return terms.

Is the worst still to come? Economic activity, as expected, has collapsed. We’re in depression territory. We can see that many corporates will have bought themselves some time with the heavy capital markets activity over the years. But revenues, profits, debt and credit metrics and the like will have come under some pressure in Q1, much more in Q2 and will likely fall through the floor in Q3.

Issuance in the HY market since 2003: No deals since Feb 20th

The huge bailouts will help only at the margin – if at all – for the largely orphaned high yield sector, so much more reliant on some form of economic growth, of which we now have none.

The IG market machinery has restarted, or has resumed some kind of traction as primary has reopened, investors have piled in, outflows have been limited and there has been little sign of real panic (even if it lost a record 7% in March) – not unlike what we saw in 2009. The same can’t be said for the high yield market.

There hasn’t been a deal since February 20. It’s not clear whether the bailout/stimulus will only help the larger corporates – but it likely will. We sense that there is trouble down the road for ‘smaller’ (read lower-rated) HY corporates. And that means for investors, too.

High yield deals (in pink) have been stopped in their tracks.

In addition, the big back-up in spreads in IG has made the high yield market less of an attraction – or a necessity. We have positive coupons everywhere for a change, even as the ECB is in lifting the market, having sucked up around 25% of the IG non-financial market with its €200bn of QE purchases.

The point being, the high yield market is almost a completely unknown entity at the moment. We have no visibility. The HY credit outlook is bleak. There is no buyer of last resort. IG funds are not going to veer into this market as they did before, satisfied right now with their fill of IG primary. And 1% – 4% yield to maturity in IG (the GM curve offers 7%) is good enough, for now. The yield tourist is staying at home, ‘locked down’.

⏰ Tick tock, tick tock, tick tock…

So credit in cash closed unchanged in last week’s final session, across the board. The deal flow took in just Red Electrica’s €400m 5-year offering at midswaps+120bp, where interest for the deal of €1.9bn still saw the pricing tighten by 45bp versus the initial guidance. Danaher tapped each of its March deals with a 3-tranche tap for a combined €750m.

Including those taps, this month’s issuance after just three sessions – and including the Danaher taps, is up at around €20bn!

The other deals of note came from Grenke Finance which issued €200m and Leaseplan took €500m in a 5-year in green deal midswaps+375bp.

The iBoxx IG cash index closed unchanged at B+251bp, the HY index (likewise unchanged) was left at B+775bp and the AT1 index closed at B+1143bp. Primary bereft of sterling – just the odd issue – has helped some recovery in sterling spreads and the IG sterling index at B+247bp. This index is outperforming with spreads 27bp tighter in the past week.

The contraction in activity was apparent in the PMIs which saw Italian services drop to 17.4, the French and German ones to 27.4 and 31.7, respectively. The Eurozone services PMI fell to 26.4, all highlighting a massive drop in activity where the composite index fell to 29.7, for the latter. Those awful numbers were added to as non-farm payrolls broke an almost decade-long streak of additions to show 701,000 job losses in March.

With more of that to look forward to, we can only think that the high yield market is storing up some more serious issues through Q2. Hold on.

The FTSE lost over 1% in the final session last week, the Dax gave up just 0.5% and the S&P eventually succumbed just -1.5%, having been lower for much of the session. Rates didn’t do too much, with the 10-year Treasury left to yield 0.60% (-2bp) and the Bund in the same maturity closed unchanged to yield -0.44%.

We’re heading into Easter and the economic data flow is a lot lighter this week. Thereafter an into next week after Easter we are heading into the US earnings season for Q1 and that will serve as bit of a distraction away from the Covid-19 disaster.

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.