21st January 2016

Correction or crisis?

FTSE 100
5,674, -203
9,392, -273
S&P 500
1,859, -22
iTraxx Main
99bp, +3bp
iTraxx X-Over Index
395bp, +9bp
10 Yr Bund
iBoxx Corp IG
B+181bp, +4.5bp 
iBoxx Corp HY Index
B+624bp, +22bp
10 Yr US T-Bond

Tighten the belt more than a notch… There’s a realisation everywhere now, we think, that we have lost the opportunity afforded to us from low rates, yields and excess liquidity over the past 7 years to restructure ecomomies, alter mindsets, and do something new to change the old order of trying to grow all the time at a high level. We’re still chasing greed, fearful of the pain of going cold turkey. As it is, policy will be to keep pushing on that string to keep the status quo intact. Well, more and more – and we know it’s barely been 3 weeks, the market looks like it will finally to work for the politicians. That means brace yourselves for a further decline in growth, asset prices, returns and so on as not just China readjusts, but we all do. That’s certainly what the tea leaves look to be telling us. And for tea leaves read oil. Glut, over supply, lack of demand, shale or whichever of those leads, it doesn’t matter. We’ve said it before, the will of the market is to take the price to $20 per barrel. That’s another 30% lower from here. Stocks and corporate bond prices will react accordingly across the board whether deserved or not. And we have already, in several comments this year, made the case for IG corporate bonds. Always known for being an optimistic, if not having a bullish stance for the corporate bond market, it is difficult to be upbeat. That doesn’t mean we are looking at catastrophe – we’ve had worse years, and recently – but the path of least resistance is for more weakness. Stocks indices might be down 10%+ YTD – more in some cases, while the IG corporate bond index is just 1% or so lower. But try selling a triple-B corporate bond, and soon that 1% will ratchet higher. So hold, savour the income, be assured the bond will not default and receive par at maturity whenever that might be.

Shellshocked and few spared… The oil price per barrel dropped through $28, giving up any pretence of resisting, and closed down almost 7% (WTI). That left us at the upper end of the $27 per barrel level for Brent, while WTI was in a $26-handle area. European stock markets fell by almost 3%, having tried to claw some back mid-session. Shell reported a woeful 4th quarter and announced thousands of job cuts, IBM overnight warned on 2016 profits, the rouble (and others) hit a record low versus the dollar, and only safe-haven assets rallied hard. Bund yields dropped 7bp at one point (10-year) and the equivalent Treasury bond was comfortably back below 2% (now yielding 1.98%, having been up at 2.28% earlier this year). Both equity and bond prices of energy sector and idiosyncratic event risk-maligned single names have been battered. In corporate bonds and in the energy sector, the likes of Glencore and Australia’s Origin Energy have seen precipitous price falls, as have Casino and Unicredit for the idiosyncratic side of the equation. Monte dei Paschi has dropped more – but they’re a special case, and always have been! The rest? They’ve barely moved – yet. Microsoft, Rabobank, Unilever and Roche for example have been solid, while even Italian utility SNAM has seen its 2023s move only 25bp wider. For now, credit is behaving as we might expect, but outflows might change the picture. Then low-beta corporate bonds will come under pressure, as they will be the “easiest” product to sell. February could yet be a painful month.

Woeful Wednesday… Over 500 points lower on the Dow and more than 50 points on the S&p, or over 3% in both cases and it looked like Armageddon. We recovered. Oil closed lower at $27.84 per barrel (Brent) and $26.55 (WTI). The DAX lost 2.8% in the session and is now down over 12% YTD. Other European equity bourses gave up between 3.5-4%. The 10-year Bund yield was down at 0.48% and the 2-year saw a record low of -0.42%. Southern European sovereign bond yields joined the basket case that is EM, with Portuguese, Italian and Spanish yields all rising by between 5-15bp as the market started to think, or believe “global financial crisis”. It might feel like it, but we’re not there yet. A shocked investor base is largely sidelined. They are stuck with positions and unable to trade their way out of them. Each selling care – and that’s all we have – is a notch on the post and reason for the Street to be marking the market wider. The Markit iBoxx IG corporate bond index finished the session at B+181bp, while the HY index was 22bp wider at B+624bp. Not good! The yield on the latter shot through 6% to 6.15%. Main and X-Over moved similarly wider, better bid at 99bp and 395bp, respectively. These are easily the widest levels in over a year.

We had better stop at this point, no need to keep digging. Try and have a reflective 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.