23rd July 2017

There’s some (high) yield in there, somewhere!

iTraxx Main

51.7bp, -0.5bp

iTraxx X-Over

235.7bp, +1.1bp

10 Yr Bund

0.51%, -3bp

iBoxx Corp IG

B+105.7bp, +1.2bp

iBoxx Corp HY

B+289.8bp, -0.3bp

10 Yr US T-Bond

2.24%, -3bp

FTSE 100 (live) [stock_ticker symbols=”INDEXFTSE:UKX”  static=”1″ nolink=”1″] DAX (live) [stock_ticker symbols=”INDEXDB:DAX”  static=”1″ nolink=”1″] S&P 500 (live) [stock_ticker symbols=”INDEXSP:.INX”  static=”1″ nolink=”1″]

High yield spreads set fresh records…

Plentiful issuance can lead to repricing of the secondary market. This is usually the case, but there are periods when that supply/demand ‘relationship’ has broken down. The last two weeks are a case in point. We have had a plethora of high yield deals. There have been a couple of deals pulled as well. A couple of borrowers were also forced to reprice higher or at the upper end of the initial guidance. Some would suggest we have too much issuance and more discerning investors.

We would certainly agree with the latter, which suggests a healthy market stance all being told. It’s not the first time a deal has been pulled or repriced higher and the end of the market has been called – wrongly. We’re open for business, but it must be sensible business.

High yield spreads, as measured by the broad Markit iBoxx index, are at record tights (B+290bp, -124bp YTD). In the opening week or so of the month we barely had any issuance in IG, some volatility around equities and rate markets in that period – and some weakness in spreads in high yield. But over the last two weeks, into the deluge if supply (and admittedly some market relief at Yellen’s dovish testimony), spreads have ground out some good performance.

Actually, the index is at a new record tight level. The investment grade index is closing in on B+100bp as spreads in this market grind out some performance amid relatively lower levels of issuance – and the index levels is currently at the lowest level seen this year so far. We have just 12bp to go before we hit record low levels.

Interestingly, issuance levels are running at a record rate for this market year to date. Seemingly, we can’t get enough – of the right deals. And high yield corporate debt does offer some protection against the early stages of higher rates. With the economy also on a surer footing (China, the Eurozone and US all chipping in), fundamentals offer a supportive dynamic in the investment process. For the moment it is a “win-win” and we can expect spreads to continue to grind better so long as nothing untoward happens – in, say, equities to derail the confidence investors have in high yield markets (close correlation between the two asset classes in extremis).

We’re still of the view that we will see spreads grind out further performance. Those record low levels are in sight for IG spreads, which is some going given the potential banana skins the markets have faced over the past year. Total returns have been eaten into though by the back-up in rate markets, but 2017 was never going to be a great year for fixed income – anywhere – given the low yields on offer, but also the potential for the recovering growth outlook to have asset allocators favour equities.

However, as we suggested in a Bloomberg article a couple of weeks ago…“We would need much, much higher rates on the back of higher growth and inflation, then I would think that the positives derived from the boost to credit fundamentals would be outdone by the potential for rotation from credit to equity as investors chase capital-appreciation strategies instead of capital-preservation ones.”

But what about me?

Not forgetting the investment grade market, spreads have been edging better session-on-session. It’s worth noting that the ECB has lifted non-financial debt – almost 15% of the eligible market – of over €100bn, now at €100,338m. We would say that the ECB’s support has not been obvious given that they hold so much of the market. Investment grade spreads measure by the broad Markit iBoxx IG corporate bond index are 30bp tighter YTD (very good) and 6bp this month so far (very good, too) at B+106bp, but it has not been obvious over the past 14-months of the ECB’s QE effort that they have necessarily promoted that tightening trend.

For the record tights in IG, and before the index change of the underlying, we’re looking for B+94bp. As suggested above, we don’t see why we can’t get there this year. We are surprised by the stellar performance of IG given the more disjointed trajectory in the tightening in spreads last year. It could just be that with €100bn+ of QE debt – supposedly permanently – taken out of the market, we are seeing the inevitable consistent grind better and reduced volatility in the spread markets. And of course, a push down on the high yield market as traditional IG investors look for yieldier paper in this market.

As if to highlight the confidence in the credit markets, even the iTraxx indices are rallying, but it is the X-Over index which is benefitting most at the moment. The cost to protect higher yielding risks is falling, in line with economic improvement and the tightening we are seeing in the cash market. The X-Over index is down at 236bp while Main is struggling to get below 50bp (at 51.7bp).

Primary surprises to the upside

After a fairly light opening two weeks to the month, the primary market has been quite busy given the time of the year. Admittedly, in IG, acquisition related financing has boosted the levels of issuance, but it has been much welcomed. We’re up at just over €10bn for the month following less than €4bn in those opening couple of weeks, with Thermo Fisher’s €2.6bn topping the list.

The total year-to-date now comes in at €173.7bn and leaves us on course for somewhere in the order of €250-270bn by year-end which would leave us at around the average of the past several years. Senior financial issuance has been light, with just a paltry €2.25bn from two borrowers.

The story, though, up until last week anyway, was around the high yield market with a fairly brisk level of activity delivering €5.9bn so far this month. And we think there is more to come this week before we really do close up for business for the summer. The run-rate for high yield issuance is on course for a record year, given that we’re up at over the €40bn mark in the year to date.

ECB straight bats it, but euro strength dampens any rally

The ECB isn’t for turning as it maintained its commitment to €60bn of purchases – and more if necessary should the outlook deteriorate. That wasn’t what the market had expected given that it was looking for the opening salvo from the central bank on the potential for tapering of purchases. So they avoided a taper tantrum at last week’s meeting, but we dare say one will come when they eventually do decide to drop the language/policy. Maybe September? So nothing new really came of the meeting as they retained the status quo on the deposit rate, the refinancing rate, views on inflation (or lack thereof) and anything else one can think of.

The unchanged policy stance and the generally dovish language in Draghi’s subsequent press briefing will have come as relief to rate markets – and total return players in the corporate bond market. We would now think that benchmark 10-year Bund yields can play out in a new range in the 0.50 – 0.80% having popped higher out of the pre-July long-established 0.20 – 0.50% area.

There will also be enough for reason for spreads to push on. After all, improving macro will likely ride roughshod over any fears which might emerge in due course around rate markets. Anyway, yields have quietly slipped lower with the 10-year Bund at 0.51%, OATs at 0.75% and even Gilts back below 1.20%, at 1.18% – all in the 10-year maturity.

For the month-end week ahead, it’s for sure the last real opportunity to get any meaningful deals away as we expect the market to be in full summer holiday mode. There won’t be much happening. The earnings season might be the driver for asset prices (equites) valuations and volatility (although the VIX is at a low 9.53%) and likely set a tone for credit spreads. That said, we are going to be looking for the steadiest of grinds better in credit spreads through the summer weeks, coming out the other end in September with the IG iBoxx index close on B+100bp and the high yield cash index at possibly a sub B+260bp level. The poor levels of liquidity in secondary will have a disproportionate impact on high yield spreads into a positive backdrop.

Bullish? You bet.

Finally, we closed out last week on bit of a downer for equities in Europe with the strengthening euro responsible for the decline, and export reliant Eurozone stocks particularly in the wars.

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.