11th January 2018

That timebomb keeps on ticking

iTraxx Main

44.3bp, -0.5bp

iTraxx X-Over

229.0bp, -1.5bp

10 Yr Bund

0.53%, +5bp

iBoxx Corp IG

B+90.5bp, -0.7bp

iBoxx Corp HY

B+275.8bp, -0.5bp

10 Yr US T-Bond

2.54%, -1bp

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″]

Bullet-proof credit…

The vigilantes in the bond markets are serving up much bearishness around fixed income risk the moment. But rate and credit markets are continuing to defy them – and gravity. Of course we are anticipating some weakness, because after all – we are in the throes of a macro growth spurt while central banks are trying to normalise.

But our forecasts are that 10-year US Treasury yields will barely see 3% by year-end (more likely 2.8%), or that the equivalent Bund yield might only rise into a 0.7 – 0.8% range is hardly a catastrophe. And we are predicting that come the end of the year, IG credit, as measured by the cash iBoxx index, will be in record territory – just as it is already and that the HY market will also find itself in the same place.

So in our view, a moderate back up in rates will not cause payment difficulties for the corporate sector, funding rates are still going to be ‘affordable’. And we will get the odd Steinhoff-like event but it will be limited to single name dislocations, which for a balanced portfolio is “noise” and simply the fee at the door to enter the club!

Credit will, of course, benefit from better economic fundamentals as they boost corporate credit worthiness with the bid staying intact for the foreseeable future. Because we are not bursting at the seams from a growth perspective and there is massive suspicion as to the valuations currently in the equity markets, the rotation trade (credit to equity chasing capital appreciation) is unlikely going to occur in any noticeable way.

Therefore, in a sense, credit maintains a safe-haven like lure for asset allocators, and we would think that positioning for incremental yield will be gained by staying with higher beta risk – corporate hybrids, increasing CoCo exposure – while there will be a more cautious increase in exposure to the corporate high yield market. The latter could come under some pressure if equities sell-off in a meaningful way, given the high correlation between the equity and high yield markets.

Despite the fears, investors haven’t been shy in coming forward and lifting those new sovereign deals. Italy’s 20-year deal on Wednesday garnered orders of over €30bn! Even the US Treasury auction got away very well. Yields are going to rise – but steadily, as suggested from our forecasts above. They will eat into returns for the year. But credit will still, in our view, see IG return upwards of 1% and HY close on 3%. Given where we are in terms of current spread levels, yields and the economic cycle, that’s not bad going.

Primary slows a little

Deal of the sesion went to Banca Monte dei Paschi

The new issue market did enough to keep investors engaged and very interested – because some of the borrowers were high beta in nature. Yieldier assets are sought after at the moment.

Portugal’s electricity transmission and gas transportation operator Ren Finance was in the market for €300m through a 10-year maturity deal at midswaps+80bp, priced 20bp tighter than the initial guidance on order books of almost €2bn.  And the borrower was the sole IG non-financial corporate in the session.

Other deals included Italian investment group Exor, which also issued a 10-year deal, but for €500m at midswaps+95bp (book 3x), while state-owned Deutsche Bahn issued €1bn in a Dec 2017 maturity at midswaps+10bp (-10bp versus IPT). The first high yield deal of the year was in sterling as the UK property information group Zoopla priced £200m in a 5.5NC2 senior note structure to yield 3.75%.

In the senior bank market, Unicredit printed €1.5bn in non-preferred debt at midswaps+70bp. The deal of the session, though, was Banca Monte dei Paschi’s €750m 10NC5 Tier 2 issue priced to yield 5.375% (-37.5bp inside the opening yield guidance). The book was over €2.5bn.

And to maintain with the new year’s sovereign issuance, we had the double-B rated Macedonia issue €500m in a 7-year maturity priced to yield 3% (also 37.5bp inside the guidance), with demand up at €3.5bn for the deal.

ECB upbeat, Eurozone in expansionary mode

The litany of economic reports were all upbeat in the session. Spanish industrial production for November beat estimates as the sector grew by 4.2% year on year, while the Eurozone’s industrial production rose 1% in the month versus 0.4% growth in October. Germany’s economy grew at its fastest rate in 6 years in 2017, at 2.2%. And according to the ECB policy wallahs, the region is now in full-fledged expansionary mode as they now seek to shift focus to the increasingly self-sustaining expansion. They will be looking for some of the desired inflationary forces to come into play as capacity constraints bite as the output gap narrows.

All good then. We have confirmation of economic lift-off. Bund yields rose and the 10-year popped to 0.53% (+5bp) having dropped earlier in the session. Gilt yields were unchanged at around 1.28% in the 10-year maturity – for most of the session, but succumbed to close at 1.32% (+3bp). In the US, producer prices fell by 0.1% against expectations of a rise of 0.2% which put a lid on the potential for yields there to rise and they were a basis point lower in the 10-year benchmark at 2.54%.

Delta’s Q4 earnings beat expectations, and they lifted their 2018 outlook, kicking off the US earnings season on a positive note. The US equity markets opened in the black, and were setting new records (here we go again) – but that wasn’t enough to drag European equities into positive territory – likely held back on the euros strength on that more solid regional economic expansion view aired by the ECB. Dollar weakness on the US PPI print also would have been a factor. The Dax was 0.6% lower and was the chief underperformer.

In the synthetic credit market, the iTraxx markets took their cue from the improvements we are witnessing in macro and not the weakness in European equities. Main edged lower to 44.3bp (-0.5bp) and X-Over dropped 1.5bp to 229bp.

Cash followed suit. We saw a better bid for paper which left the Markit iBoxx index at a new record low of B+90.5bp (-0.7bp) and 6bp tighter in the opening two weeks of the year. Higher yielding assets remained in vogue too, with CoCos  attracting some keen interest again, the iBoxx CoCo index left at B+333.5bp, which was 11bp lower in the session and at a new record low.

The IG market generally outperformed the high yield one, where activity remains extremely light and investors super reluctant to add much risk. The iBoxx HY index was left at B+275.8bp (-0.5bp).

Have a good day.

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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.