12th September 2016

You won’t like Bond(s) when he is angry

MARKET CLOSE:
FTSE 100
6,777, -82
DAX
10,573, -102
S&P 500
2,128, -54
iTraxx Main
68bp, +3bp
iTraxx X-Over Index
318bp, +14bp
10 Yr Bund
0.01%, +7bp
iBoxx Corp IG
B+117.7bp, -0.5bp 
iBoxx Corp HY Index
B+411bp, +2bp
10 Yr US T-Bond
1.67%, +7.5bp

A tantrum if ever we saw one…

angryIt’s all over. We’ve had – or are in throes of – the move that was always going to hurt most investors. The big move in rate markets and the massive drop in stocks. Ten-year Bund yields in positive territory (0.01%, +7bp on Friday alone), Gilt yields at 0.86% (+10bp), Italian BTP and Spanish Bono yields 10bp higher too at 1.25% and 1.08%, respectively, and it feels like carnage.

All because the Fed might add 25bp to policy rates along with questions as to whether monetary policy has had its day so far as containing this 8 year long financial crisis. Imagine we had a sustained growth trajectory, inflation on the up and even more aggressive central bank policy to stymie an overheating global economy. We would have to write-off the corporate bond market!

This latest pull-back lacks much by way of being rational, and is panicky in every way one looks at it. The moves were solely predicated on the developing market expectations – following a couple of Fed governor testimonies, that higher US rates might be (are) warranted. Because the news flow at the end of last week (and much before it), actually suggested that government bonds should have been better bid. German exports fells hard – very hard – in July, while French manufacturing was still in contraction.

There are no “gimme” trades as such, but the ECB will be easing again, in our view. And the ECB might not have “fed the fish” in the way they wanted last week, but they will eventually, albeit grudgingly. The Fed might go the other way, but the US central bank has form (lots of it) of reversing policy – as soon as. We don’t buy into the classic “what happens in America, we follow 12-or so months later.” Nor do we buy into Treasury/Bund yield correlations (the former pulls the latter). That’s because, such is the level of markets having been manipulated by central banks as a result of this financial crisis, historical precedence and trends should be taken with a pinch of salt, in our view. For example, if stocks fall hard, aren’t government bonds supposed to rally?

Still, the market has chosen to react – as it did the last time the Fed actually raised rates, by throwing its toys out of the pram. We still opine that yields will be going lower again, and that the current move in the US will start to recede in terms of the contagion impact it is having on government bond yields here.

Credit steady, benefiting from illiquidity!

One could argue that the real state of the corporate bond market in Europe is difficult to gauge because of its illiquidity. For instance, while all others were losing their heads through Friday’s session, we just closed up shop. As measured by the Markit iBoxx index, investment grade spreads actually closed a smidgen better – and at their best levels of 2016 at B+117.7bp (-0.5bp). The index yield jumped 5bp higher to 0.88% having touched a record low in middle of last week of 0.79%. That’s not to say spreads can’t gap wider should equities continue to trade with a sharp decline in prices. In February, spreads had gapped 45bp on an index basis, but there wasn’t any real depth behind that – nor were the ECB’s intentions in the public domain. We think that investors will hesitate to sell, knowing that the ECB’s hoover is permanently switched on, and any bonds the central bank sucks up will never re-emerge. So subsequently, adding risk would be a costly exercise.

Anyway, we did see a little weakness in the HY market, but the volume and flows behind it were very light. We would think more aggressive defensive marks will emerge in today’s session as investors look for an explorative bid. The index closed at B+411bp (+2), with the yield up by 7bp and off 2016 lows recorded just the day before! In sterling, we closed unchanged at G+147bp, but here the yield was also higher by 11bp. Sterling returns, are still sitting pretty top of the pile but are down YTD at just 14% (they were up at 16% a few sessions before).

The immediate impact on sentiment observed in credit was through the usual iTraxx index risk proxy where Main ended 3bp higher at 68bp and X-Over 14bp worse off at 318bp. They will be higher (better bid) again today, no doubt.

Primary markets will be impacted by the macro volatility

galp-gas

€500m deal: Galp

We could reasonably expect the new issue markets to slow for as long as we get the pre-Fed shakeout afflicting pain on equities while that back-up in government bonds will have many flapping. Galp Gas got €500m away on Friday and the total IG non-financial issuance for the month now stands at €10.55bn – or, a little over €190bn for the year to date.

We have the BoE’s monetary policy meeting this week – they won’t change anything. There are a few Fed speakers slated convey their thoughts and they will be closely monitored. There’s US data at the end of the week (retail sales, CPI). Otherwise, it’s going to be a difficult session today, following the acceleration of the fall in the S&P on Friday (-2.45%). The VIX closed 40% higher at 17.5. The DAX has snatched defeat from the jaws of victory having ended just one session in the black all year!

Good luck. Back again tomorrow.

Suki Mann

A 25-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 Credit Market Daily.