13th October 2019

Tunnel of love

iTraxx Main

53.8bp, -2.6bp

iTraxx X-Over

239.7bp, -8bp

🇩🇪 10 Yr Bund

-0.45%, +4bp

iBoxx Corp IG

B+122.6bp, -2bp

iBoxx Corp HY

B+414bp, -12bp

🇺🇸 10 Yr US T-Bond

1.73%, +7bp

🇬🇧 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″]

Green light and it’s a go…

In a flash, the tone is massively upbeat. Trade tariff talks have apparently gone well between the US and China and we are in de-escalation territory. Meanwhile, we have the makings of a deal on Brexit and markets rallied hard into the final session of last week as a result.

Should the positive tone follow through into some sort of reality of a deal in both situations, then we are set up to rally into the end of the year. That’s a biggish ‘if’, but it is not impossible. And for the moment, investors will likely choose to (almost) ignore the event risk which might emerge from the Middle East.

The play-off in what’s remaining of this final quarter will then be between the improved headlines on those deals (trade talks/Brexit) against the difficulties in global macro. We suspect that the former will win out and that risk assets rally into year-end, but it will leave us looking at a much more difficult 2020.

Because economic growth levels will continue to remain under pressure, recession risks lurk in several jurisdictions, the Fed will be cutting rates several more times as rates head to zero (wage growth, PPI and CPI all falling) and we will be thinking (quite possibly) about that headline Bund yield heading back towards the -1.0% level.

In that sense, the current sell-off in Bunds, taking the yield back to -0.45%, might have gotten ahead of itself.  After all,  it was -0.74% several weeks ago. Whatever, this year’s fixed income blockbuster total returns (Eurozone rates over 10%!) will be seen as an aberration and a ‘once in a generation’ event.

The upshot is that we’re all going to need to work harder to outperform in 2020. The risks will only increase and risk taking will need to rise to squeeze out that extra relative performance. Investors will be sitting on their highest levels of credit risk.

Credit markets, though, will likely retain their defensive characteristics – but meagre returns across all fixed income asset classes are what we will be looking forward to. Much of next year’s outlook and performance is going depend on how markets react to the impending QE-related purchases after November 1. It is not a ‘gimme’ that spreads squeeze tighter on the back of it – we didn’t through various periods in the 2016-2018 QE period.

Primary run rate edges down

The only deal of note on Friday came in the high yield market with Nexi in for €825m in a 5NCL priced to yield 1.75% as it sought to refinance existing debt. The sizeable transaction took the year to date high yield volume over the €50bn mark, to €50.6bn.

There is a decent pipeline and rallying or well-supported risk markets will help sentiment and promote further issuance to have us up at around €60bn come year-end.

HY Issuance by Month:

High Yield Issuance. Click the chart for more detail & charts.

The week’s business in IG might have concluded on Thursday, but we still had €10.2bn printed led by Hutchison Telecom’s €4.2bn 4-tranche transaction, with Enel lifting €2.5bn in a 3-tranche sustainable bond deal. For the year to date, the total has risen to €262.5bn and we are heading for a record year.

The senior financial total is up at €138bn and already ahead of the full-year totals of 2018 (€130bn) and 2017 (€136bn) as it closes in on the €145bn issued in 2016.  This chart illustrates the increase:

SF Deals since 2003. Click to see all deals in detail.

Brexit premium unwinds, risk assets rally

Whatever the finest details of any deal might be, the Brexit and trade war premia unwound in style on Friday. The noises in Washington were good while the two sides on the Brexit debate entered the so-called ‘tunnel’ to thrash out the details of any deal.

DAX: Up 3%

What we saw was a massive relief rally in German stocks in particular, with the DAX zipping almost 3% higher, other bourses across Europe were 1.9% (or more) higher but FTSE lagged as sterling rallied hard, rising by 0.8%.

In the US, stocks were up by 2%, before closing just over 1% higher. Nevertheless, the S&P is once again closing in on record territory – needing to add less than 2% to get there!

In bonds, Gilts sold off and gave up another 10bp (after rising a similar amount the day before) to 0.68% while Bund yields gained 4bp to close at -0.45%. Treasuries joined the sell-off even as event risk continued to rise in the Middle East with markets more focused,  for the moment, on the trade talks. The yield on the 10-year closed at 1.73% (+7bp).

The synthetic indices dropped lower again as the cost of protection declined for the second successive session and we closed the week with iTraxx Main at 53.8bp (-2.6bp) with X-Over left at 239.7bp (-8bp).

We also saw a tightening in the cash market for the second successive session and it meant that the index was also tighter in the week following weakness in prior sessions. The iBoxx IG index closed at 122.6bp (-2bp).

The AT1 market wasn’t going to miss out on the improved sentiment and although flows were light, the Street was busy tightening up the market. The index closed at B+483bp which represented a 23bp tightening in the session – and that’s the best level in a month. Total returns for the year to date rose to 12.7%.

And we had exactly the same dynamic in the high yield market. The trigger was obviously the equity rally and spreads tightened 12bp, leaving the HY iBoxx index at B+414bp.

For this week, the UK parliament is back in action and we have the EU summit. Next Saturday, parliament sits for the only the fouth time in the last 80 years on a weekend. By then – at the very latest, we will know if we’re going to get a Brexit deal.

Elsewhere, the US earnings season kicks off with BofA, Citi, JP Morgan and Wells Fargo with the likes of Netflix, IBM and Schlumberger set to follow. Earnings are set to decline but they’ll generally beat analysts forecasts as is per usual.

There is a host of data due from China including GDP growth, inflation and industrial production along with VCPI, PPI and loan growth numbers. And we have a similar deluge of data from the UK and Eurozone.

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.