30th June 2019

Please, sir, I want some more

MARKET CLOSE:
iTraxx Main

52bp

iTraxx X-Over

252.5bp

🇩🇪 10 Yr Bund

-0.33%, unchanged

iBoxx Corp IG

B+124.8bp, -0.5bp

iBoxx Corp HY

B+418.5bp, -5bp

🇺🇸 10 Yr US T-Bond

2.00%, -1bp

🇬🇧 FTSE 100 6076.60, (-2.29%) 🇩🇪 DAX 11586.85, (-1.65%) 🇺🇸 S&P 500 3044.31, (+0.48%)

Everyone’s a winner…

We are needing to go some to match that first half. It was just about the best six month period ever for markets as equities, rates, credit, most commodities and even Bitcoin managed the most impressive of returns. For 2019 overall, we actually don’t need to match it to register a good year, and even if we give a little back it would be view as being a super year. Equities 17%+, Eurozone rate market 6%, IG credit over 5.5% (iBoxx), HY credit close on 7.5% and the AT1 market 10%. As good as it gets?

A second QE-inspired government bond programme will see market yields likely plummet from these levels, where -0.50% on the benchmark 10-year Bund yield (currently -0.33%) would be unavoidable and just a quick breather on the way to -0.75%. We wouldn’t be surprised in that situation if the whole German curve – to 30-years, saw negative yields.

Coming hot on the heels of that – or in conjunction with it, a second corporate bond purchase programme by the ECB will see IG and HY credit spreads crunch lower and head into record territory. There’s a way to go, but we will get there cross all credit markets. The iBoxx IG index yield is already at around its record low (0.74%) and an ECB involvement in the credit market at these levels would leave the resulting grabfest pushing those yields to sub 0.50% levels.

As things stand for credit investors, it would appear that we will add to those returns, if anything. There are many risks on the horizon and, admittedly, the US-China trade war looks like it is going to spiral into something much more sinister. That will add to the macro gloom. There are a handful of other geopolitical developments which are brewing nicely and have a non-trivial probability of disrupting risk markets.

But, policymakers are ready to step up. Lower rates, QE and the like are ready and on standby. For credit, the European default rate is effectively zero (well, it’s 0.9%) and lower rates would leave more cash chase a safe-ish fixed income product. See above!


What a first half that was!

The rising tide really did lift all boats. Unprecedented – certainly in recent memory, just about all asset markets had an excellent first half of the year. Credit first. The AT1 market (iBoxx index) returned 10% in the first half on iBoxx index spreads a massive 186bp tighter. At B+523bp we are not even close to the tightest spread levels seen on this index (B+288bp) and we would think that it is unlikely we get there because the product trades on a yield basis. Nevertheless, the crunch lower in the underlying might see us get close. After all, the lowest yield seen on the index is 2.84% versus 4.61% now.

The IG corporate market is up 5.6% year-to-date on spreads 48bp tighter but we are still off the 2019  index low of B+122bp (now at B+125bp). In June, IG credit returned +1.5% alone – the AT1 market was up 3.7% in the month. We are on course, we would think, for a sub-100bp spread level for the IG index, where any ECB QE resumption will see us test the record B+83bp index low. Returns for this year could be heading for the 8% level should we continue with the current trajectory.

Returns YTD

The excellent performances have been reflected across the fixed income product space. High yield total returns are at 7.4% and on the way to 10% for the full-year, without there being anything spectacular. For June, the high yield index was up 2.2%. The iBoxx index has tightened 105bp in the first half. The default rate is less than 1%.

Sterling corporates have likewise been very well supported and returned 7.3% while the Eurozone sovereign market is up a stunning 6% in the first half.

As ever, equities have been outperforming. The Dax and S&P share top spot with returns in the first half at +17.5% , the Dow is up 14% and the FTSE 10.5%.


IG primary eyes record year

With costs plummeting and investors willing to fund borrowers at ever-lower levels, the corporate sector stepped up to the plate in the first half. For the IG non-financial corporate bond market, the run rate for the first six months is the best since post-crisis and, with a little push, it might just get us over the line for it being a record year.

We’ve had €166.5bn issued in the first six months, just €5bn ahead of the level recorded in 2016 when the full year total came in at €271bn. With the ECB mooted to embark on a fresh QE programme perhaps some time at the end of Q3/early Q4, there is a rising probability that we might be looking at the second best year ever (€285bn in 2009 being the best).

Even if there is no CSPP, the threat of one and/or a continuation of the low yield environment has this market in good shape. We must be looking at upwards of €250bn as a minimum level for the full-year – with there still being little or no impact on the secondary market given the demand for paper, as inflows into credit continue apace.

Medtronic: Huge numbers

We have had an unusually high level of multi-tranche issues with Medtronic being the largest borrower, a total of 11-tranches (including a tap) seeing the US borrower hoover up €11.5bn in the process. US domiciled borrowers are the biggest grouping in geographical terms with 33% of the market, followed by the French (21.5%) and German issuers (15.2%).

IG non-financial corporate issuers who have transacted three or more tranches in a visit is also unusually high, with some 22 deals done this way in the opening six months.

The Senior Bank Primary market has been going gangbusters, relatively anyway. The €24.6bn of senior issuance in June makes it the best such month since 2010. The huge €97.7bn of supply in the first six months compares favourably with just €130bn for the full year in 2018.

Senior Issuance: Best June in years

There is the usual seasonal slowdown through the summer months to contend with, so we would likely be looking at somewhere in the region of €170bn for the full-year as a target.

The high yield market has done reasonably well when considering the expectations most had for it when we began 2019. Weakness in spreads and lower volumes were the general themes (from us included). However, secondary has surprised to the upside and total returns have been in excellent territory.

The primary market also falls in that ‘reasonably well’ bracket with €29.4bn issued in the opening six months. The pipeline is significant and receptivity to deals will only increase if the ECB starts another CSPP as IG investors once again face a crowding-out dynamic. As a target for the full-year, we are revising higher our expectations from the low-€50bn area and likely looking at something in the region of €60bn now.


What next?

More of the same will do nicely. However, that is an unreasonable expectation in that we are not likely going to be doubling up in performance terms in the second half. But we can possibly gain another 50% on top of what we picked up in the first half.

For that to happen, macro will need to edge lower – and threaten worse. The geopolitical outlook is going to have to remain as uncertain as it is now and we are likely going to need little real progress on US-Sino trade talks. Because, if it stays like that, then central banks will be looking at easier policy and markets will react to that.

Bond prices higher (yields further into negative territory, that is), equities higher anticipating lower rates and credit spreads tighter as money flows into the asset class looking for fixed income positive yields, which will drive credit spreads tighter.

As suggested above, spread markets are nowhere near their record lows and while underlying yields have plummeted, spreads will need to react soon. At worst, spreads feel a squeeze through the summer. High beta and longer duration is where the outperformance will be still.


June close

Rates markets closed last week’s final quieter session a little better bid, with the 10-year yields at 2.00% (US Treasury), -0.33% (Bunds) and 0.83% (Gilts). Some month-end jostling of positions helped equities put on up to 1% (Dax outperforming).

Primary: VW Bank €500m deal

In credit, index closed lower with iTraxx Main at 52bp and X-Over at 252.5bp. The cash market was quiet but slightly better bid with the iG iBoxx cash index at B+124.8bp (-0.5bp) with the HY index at 418.5bp (-5bp) and close to recovering all of May’s weakness through June. In primary, Friday’s deals came from IAG (dual-tranche, €1bn) and VW Bank for €500m.

Over the line and now into the second half of 2019, and the big news will be on Trump becoming the first sitting US president to set foot on North Korean soil, following that ‘impromptu’ meeting on Sunday. We’d think that the market will see the positive in it, even if the political strategists will possibly have a different take on the situation.

The G20 ended with the US and China agreeing to resume trade talks and Trump halting any further imposition of tariffs, with perhaps a lessening of the pressure on Huawei. Again, another good development for the market, especially as it potentially limits downside macro risks. We’ve been here before, though, so any positive impact might be short-lived.

Other than that, the week will likely cram in any primary activity in the opening couple of sessions ahead of the shutdown the US for Independence Day (Thursday), with activity unlikely to pick up on Friday ahead of the non-farms payroll report (+160k expectations). We’re busy on data with manufacturing and service sector ISMs due as well as auto sales and factory orders.

We have manufacturing and services PMIs for the Eurozone, as well as unemployment and PPI data.

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.