15th May 2017

Yet another ‘new normal’

FTSE 100
7,345, +49
12,770, +59
S&P 500
2,391, -4
iTraxx Main
63.2bp, +0.8bp
iTraxx X-Over Index
257.7bp, +2.8bp
10 Yr Bund
0.39%, +-3bp
iBoxx Corp IG
B+115bp, +0.5bp 
iBoxx Corp HY Index
B+319.5bp, +2bp
10 Yr US T-Bond
2.33%, -7bp

High yield record lows: spreads and yields

2007: It was a different market back then, in every sense. A multi-year CDO/CSO structured product bid for cash and synthetic credit risk had a severe distorting impact on valuations. The unprecedented level of market leverage (unquantifiable in every sense) resulted in cash and synthetic spreads/indices heading towards or residing at then record tight levels.

Fast forward 10 years and the Markit iBoxx cash high yield index is back at levels not seen for 10 years (B+319bp). The index benchmark changed in 2008 (spreads versus benchmark remarked higher), so a direct comparison between then and now is not possible – nor relevant.

2017: Importantly, there’s also a level of distortion in the market now – that of the record low rate environment and central bank QE operations having a similar “sucking liquidity out of the bond market” impact as the leveraged bid back then. Nevertheless, and it is even more impressive after taking into account market size – spreads in the high yield market are at all-time tights.

The fledgling high yield bond market in Europe had just €85bn of debt in the index in 2007. We have recently had several €50bn+ years of supply. If we then take into account redemptions and bond refinancing at lower funding levels as well as the small matter of an opening up of the market as a result of the aforementioned central bank policies promoting funding disintermediation, the index size has ballooned to €325bn.

So, the market has quadrupled in size and spreads are back at pre-adjusted 2007 levels – that is, high yield market spreads are recording new record lows. Furthermore, the index yield in 2007 was 7.63% (spread B+318bp) versus a record low 3.02% now (for the same spread).

It all leaves the high yield corporate bond market in record territory – in terms of corporate bond spreads, bond yields and market size. And guess what? There’s more to go.

There is no let up in the demand for product, the once fledgling market continues to evolve and we’re into a potentially sustainable positive macro (growth phase) environment that would underpin credit fundamentals (and a low default rate). With the removal of the current policy accommodation only likely going to occur in very measured fashion, the current spread tightening trend has legs in it yet. With returns already up at 3.4% YTD, we can see more flows of cash being directed to this market.

Risk sentiment is now the only hurdle to a sub-300bp level in the iBoxx cash index. Any material sell-off in stocks would also have an impact, but other than that, macro, demand, flows and sentiment are supportive for further tightening.

Mixed end to the week

Walmart reports this week

Disappointing retail sales and lower than expected inflation in April in the US made for a weaker session for equities into the end of last week. Bond prices went up though and yields lower – in Europe as well. Gilt yields were down at 1.09% (-7bp), the 10-year Bund closed to yield 0.39% (-3bp) and OATs at 0.84% (-4bp).

In the US, Treasuries rose leaving the 10-year to yield 2.33%. European equities were in the black by up to 0.6% but US bourses were in the red, and the S&P again failed to close above 2,400 (at 2,391).

In the corporate bond market, we had a slight back up in spreads but it wasn’t a particularly exciting final session in which to end the week. Far from it, the Markit iBoxx IG corporate cash index was up at B+115bp (+0.5bp).

The high yield market played out the same way, with spreads a touch wider for choice and the index up at B+319bp (+2bp). For both markets, that’s effectively a slightly defensive mark by the Street rather than any selling promoting weakness in the market. The high yield index is 95bp lower this year so far and the IG index 19bp, the latter 21bp off its record low level.

For the iTraxx indices, they also edged a touch higher, better bid into the close to leave Main at 63.2bp (+0.8bp) and X-Over at 257.7bp (+2.8bp).

The primary market spilled out a couple of deals on Friday, with IG non-financial corporates represented by Amadeus‘ increased 2-year €500m and SocGen issuing a TLAC eligible senior non-preferred senior €1bn deal. The SocGen deal took the MTD supply for senior debt (almost all TLAC eligible debt) to €10.6bn.

At around €74bn of senior financial issuance to date, we’re heading for a post-crisis high of senior debt issuance as banks scramble to fill their coffers with TLAC-eligible debt. The deal the week, just for its size, was the 4-tranche offering for €8bn from General Electric.

For this week, (as usual) equities will lead on the sentiment stakes and the weaker retail sales data does offer some cause for concern that the US consumer is perhaps reining in spending, so other retailers will be watched (Walmart, for example) when they report this week, while we also have industrial production data due. The rest will see a focus on geopolitics with Turkey’s Erdogan meeting Trump. The Iranians go to the polls on Friday.

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.