7th June 2020

📈 Why it’s Boom Time for Risk Assets

iTraxx Main

59.2bp, -4.8bp

iTraxx X-Over

342.7bp, -27.1bp

🇩🇪 10 Yr Bund

-0.28%, +4bp

iBoxx Corp IG

B+139bp, -14bp

iBoxx Corp HY

B+492bp, -27bp

🇺🇸 10 Yr US T-Bond

0.93%, +11bp

🇬🇧 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″]

Markets on turbo boost…

Can it hold? It most certainly can. That was a freaky Friday and the excitement across the investor universe was palpable. Trump was crowing. There is much suspicion, plenty of head-scratching and there certainly will be inquests as to why the economists have been so badly wrong-footed by that non-farm payroll report. After all, they were out by over 10 million. It’s no small number although there is much relief that the report was so good!

The various stimulus packages are not just helping macro find a floor, but the subsequent recovery – of which we in the early throes of, is likely going to serve to shape this economic episode close to being a V-recovery.

Few would argue that the unprecedented levels of liquidity sloshing around the markets already providing near-zero returns for fixed income (rates, property, credit) are just going to provide more fuel in the race to the bottom. There’s probably an endpoint somewhere, but we are unlikely going to reach it in 2020.

There’s still a lot of misery. And most of it is in Main Street though that non-farm payroll for May suggests that we might see the misery index start to lighten up. There hasn’t been much angst in the financial markets of late, as central bank actions stoke more asset price inflation. Equities have been the chief beneficiary.

The corporate bond market continues to pump out deals at a heady rate. Can it continue through June and the other summer months? We think it can.

It is unlikely that issuance is merely being pulled forward, and Q3 and Q4 are also unlikely going to be relative wastelands as far as the primary markets are concerned. The corporate treasurer’s dash for cash is far from over.

What we haven’t seen – apart from the obvious – is any major (or rather structural) M&A or big investment requiring funding. That’s understandable in the eye of this pandemic storm. Then there are the delinquencies – or the default rate. It’s rising, but it is still at very low levels historically given the level of growth. That’s a function of liquidity/funding costs/ability to service debt.

The default rate is unlikely to get close to 10% (previously projected) come year-end. Unless we’re missing something. zombie companies could just find their way through the fog and into some kind of recovery into that projected 5%+ growth being forecast by the ECB for 2021.

So, this is not about closing one’s eyes and buying come what may. There is a method in the perceived madness. The markets are forward-looking and are looking past the immediate depressed environment and at Q4 and 2021. And as we have suggested previously, the liquidity needs a home. The high/low beta compression trade is going to be well-supported.

Opportunistic primary

The deals on Friday came courtesy of Bayer material science spin-off Covestro AG, which issued €500m in a long 5-year at midswaps+115bp and another €500m in a 10-year at midswaps+145bp. The size of the interest was at almost €11bn and final pricing some 60bp inside the opening talk for this triple-B issuer. Once again, we would say someone has judged the interest and initial talk wide of the mark!

The other IG non-financial borrower was Schneider Electric which also issued €500m, but in a 3-year at midswaps+38bp and was 37bp tighter than the IPT off a €5bn book.

A much shortened week delivered €7.6bn of IG non-financial deals nevertheless, but the recent run rate should see the monthly print in excess of €30bn (against €39bn in June last year). The total year to date is up at €217bn.

We finished with Ardagh Packaging’s €350m tap of its August 2016 issue taking the total deal size to €790m, the coupon set at 2.125% for the discounted tap (at a €96.5 cash price).

Who’d be an economist!?

Well, the US markets have surprised many a time, but none more so than Friday’s non-farm payroll result for May. The market expectations of a loss of 8 million jobs for the month was smashed out of the water, as 2.5million jobs were added. The recession will be seen to have been short and sharp. The stimulus package would have done its job. The Fed isn’t going to be getting involved anytime soon!

Of course, there are still many questions needing to be answered. And the data will be sliced and diced for a while to come. Some smell a rat. The unemployment rate, however, dipped to 13.3% against expectations that it would rise to almost 20%.

In the meantime, the lockdowns are easing and economies recovering. Cash is being put to work. The S&P is heading for a fresh record high, just 3 recession months after setting the last one.

That rising tide will lift all boats. We’re sure of it. Another 3% and the Dax will be flat year-to-date, it’s just a 1% rise for the S&P but the FTSE has a way to go, needing to put on a massive 16% before it can boast the same. The FTSE is where an opportunity might arise in terms of potential for outperformance, especially given its particular international earnings focus.

In rates, markets recoiled with the yield on the 10-year Treasury popping 11bp higher to 0.93%, the Bund yield in the same maturity rose 4bp to -0.28% and the Gilt closed to yield 0.36% (+5bp).

The tone in the corporate bond market was obviously good and that meant the cost of protection fell again, continuing with a solid streak of late of declining protection costs. iTraxx Main crunched 4.8bp lower to 59.2bp and X-Over was 27.1bp lower at 342.7bp.

In cash, we squeezed on. Actually, it was more like a huge crunch tighter in spreads. The IG iBoxx index tightened by a massive 14bp to B+139bp, representing a 36bp tightening for the week. That was the best level since early March. Total returns are now at -1.3% as the market slowly claws back much of the lost performance.

The CoCo index was 72bp tighter on Friday alone – obviously paper is scarce (illiquid market), but at B+594bp that was a 167bp tightening for the week. Since the record wides in early March, the index is over 800bp tighter. Returns year to date have improved to -2.9%.

The high yield index was only 27bp tighter in the final session last week, now at B+492bp with returns year to date improving to -4.8%. That can be considered a bit of a disappointment. However, as we suggested above, any macro recovery false dawn and this market could get crushed still.

However, IG risk has its obvious lure. While signs macro stability, reduced financial systemic risk, higher rates/steeper curves and lack of banking regulator-noise around coupon deferrals supports confidence in the AT1 market.

Nothing bad happened over the weekend. And we have a quieter week on the reporting front ahead of us. The FOMC announcement on Wednesday will be about their views on the economic outlook, rather than markets expecting any policy action. Several equity markets have a good chance of recording positive returns again for the year sometime this week – and maybe even post fresh record highs.

Credit spreads should continue their squeeze tighter. Primary will remain buoyant as corporate treasury desks take no chances with the outlook but also seek to refinance and/or add at lower and declining funding levels.

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.