14th July 2016

Corporate bonds are smashing it

FTSE 100
6,670, -10
9,931, -33
S&P 500
2,153, +1
iTraxx Main
72bp, +1bp
iTraxx X-Over Index
324bp, +3bp
10 Yr Bund
-0.09%, -6bp
iBoxx Corp IG
B+137.6bp, -3bp 
iBoxx Corp HY Index
B+478bp, -6bp
10 Yr US T-Bond
1.47%, -4bp

Corporate bond market sizzles

The Markit iBoxx index IG corporate bond yield hit a record low in the session. At 0.97% for the index, that is 5bp lower than the previous record low, and a superlative 6bp lower in yield in the session alone. Returns for IG credit, YTD, are up at 5.1%. Smashed it. These are both incredible and fantastic numbers and will continue to decline (yield and spread) and rise (returns). There’s excitement in the feat, but it comes with some concern and trepidation and we think much frustration. There’s also the heavy hand of the ECB manipulating it all. And not just in the corporate bond market but in the government bond market. They are dumbing it down and we know it – so, position for it. The hidden subliminal message is to take risk: lower in quality, and longer in duration – positioning for high/low beta compression.

The sterling corporate bond market didn’t fare too badly either! The index spread dropped by 5bp to G+174bp. The index yield fell by a massive 11bp to 2.84%. That’s illiquidity for you and this is easily the lowest spread of 2016, but it is a record low yield for the sterling corporate bond index. There hasn’t been a great deal of sterling issuance of late (in fact for the best of a year), so that helps. But few are selling, nor there has been any panic – pre/post Brexit. And total returns? A quite extraordinary and stunning 10.7% YTD. From a relative value perspective, we have to think that a few non-traditional sterling investors are looking at this market. Currency risks, poorer liquidity, the longer duration nature of it and the poorer information flow aside, surely there is some upside to be had here for them!

In high yield, we saw just a moderate tightening. Perhaps that was because the ECB isn’t involved. But the “feed through” impact into a material tightening in spreads here ought to come, eventually. Anyway, we saw the index at B+478bp (-6bp) and just 4bp off the lowest level for this index this year so far. Returns continue to ratchet better too, sitting up at 4.5% YTD. In synthetics, that more neutral equity market performance saw to it that we closed out with moderate weakness with Main at 72bp and X-Over at 324bp.

While others fizzle

Equities closed out the session slightly in the red having doing little to break out with conviction in any direction. In a way, we could have expected that following on from several strong sessions. Bond yields did a little more with the 10-year Gilt at 0.74% (-8bp), while the new on-the-run Bund yield closed at -0.09% (the old one yielding -0.014%, -5bp). Treasuries were similarly better bid, with the 10-year at 1.47% but with stocks in the US achieving yet another record close. The news flow for the day was around new Prime Minister Teresa May, as David Cameron finally left office. Oil inventories rose last week in the US, which came as bit of a surprise to markets, and we saw Brent back down trading off a $46 per barrel handle (-4%). The rest was mixed as we saw industrial production surprisingly lower in May in the Eurozone (higher revision for April though), while Chinese exports and imports fell more in June than they did in May.

And it seems like that’s it…

Judging by the damp squib nature of the primary market and the squeeze in secondary spreads as flow and volumes dwindle – while the ECB tries to lift what it can, this could really be it for the summer. Those that think this is case will be leaving a corporate bond market that is in good shape, and could be coming back to materially tighter spreads come September. Spreads as measured by the Markit iBoxx index are 17bp YTD, having been 45bp (!) wider at one stage in Q1, and returns are up at 4.7%. July’s supply, on the other hand, has definitely not met expectations and could come in lower than the poor effort from an event-risk riddled June. That month saw just €11bn of IG non-financial issuance and the total thus far for July is a paltry €6.5bn.

On this front, Wednesday’s session drew a blank. Maybe the issuance of €45bn in each of the month of March and May exhausted the pipeline for the first half (the run rate for the year is after all up at a stunning €178bn). As we enter the earnings season black-out window and are a week away from the start of the holiday season proper, there is excuse aplenty for borrowers to wait. Furthermore, if we are right, funding costs are going to be quite significantly lower in the final quarter of this year versus where they might be now. Waiting works.

With there being no rush to get issuance away, and with the ECB only having a more limited participation in that market anyway as a proportion of what it is lifting in the secondary market, we would think that spreads are likely to crunch better through the summer months. They might be the only player in town, but they have a job to do and have already signalled their intent. We would be extremely surprised if the €8.5bn of corporate bond purchases derived in the opening four weeks of its campaign is sustained. We would think that that the low-hanging fruit – so to say – has been picked, and they will progressively find it more difficult to keep that level of purchases up. We already saw a bit of a slowdown into the final week of the first four. Still, anything over €1bn will be deemed as being aggressive anything around this level will undoubtedly see spreads tighten significantly.

Although the negative yield universe continues to grow

Elsewhere, it’s worth reflecting on negative yields again. We highlighted in Wednesday’s note that Deutsche Bahn became the first corporate – albeit not what we would call a “pure” corporate – in the sense that it is owned 100% by the German government, to print with a negative yield at re-offer (new issue). In yesterday’s session, Germany sold new 10-year Bunds with a negative yield for the first time in history (-0.05%). The drip feed into longer and lower negative yield territory continues, and having engulfed the top-end of the Eurozone’s sovereign bond market, we look for a growing number of top-quality non-financial corporates to manage this feat too. Some of this on the sovereign front might be to do with Brexit’s lingering effects, but given our more cautious view on the macro economic outlook – as well as the declining eligible debt available for the ECB’s QE programme, we think the drop into negative yield territory for the Northern European Eurozone sovereign debt markets will continue.

That’s it from me for this week; Back on Monday.

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.