13th September 2016

After trudging up by the stairs…

MARKET CLOSE:
FTSE 100
6,701, -76
DAX
10,422, -151
S&P 500
2,159, +31
iTraxx Main
70bp, +2bp
iTraxx X-Over Index
326bp, +8bp
10 Yr Bund
+0.03%, +2bp
iBoxx Corp IG
B+120bp, +2.3bp 
iBoxx Corp HY Index
B+428bp, +17bp
10 Yr US T-Bond
1.67%, -1bp

…It was down by the elevator…

We had gone up in a straight line for so long that it seems some have forgotten that any pull-back does not mean that we are necessarily going down forever. The inevitable questions are being asked given the rather sudden but non-violent nature of this sell-off. But it’s not the end of the world. It feels it though for some, as we seemingly go down by the elevator – as far some asset classes are concerned. The move has not happened because economic fundamentals/data point to a recovery. But really, is this current price action warranted just because a Fed rate hike is potentially looming? We don’t think so. Not at all! And a lot of what happened in Europe in yesterday’s session was about catch-up following the accelerated fall in US stocks on Friday.

We are thinking that there will be some recovery, which will be more than just a dead-cat-bounce, at some stage this week. The markets will remain jittery nevertheless, wary of that rate hike but also won’t be helped by investor positioning. After all, who isn’t long duration in their respective fixed income asset class of choice? Amid little choice but to, investors have been sucked-in by central bank QE initiatives, and most pain will be heaped on them on any pull-back.

Wowzer from the ECB

The corporate bond sector asset purchases by the ECB saw a massive weekly lift with €2.4bn accumulated last week. That’s just €252m short of the record in the week to 27 June, while it is only the second time they have exceeded €2bn in any given week. It is also €1.3bn more than last week’s effort. It’s huge! Their intentions are abundantly clear. And we should be in no doubt that they mean business. After that, how can credit spreads go wider short of a massive turnaround in the global economy, sharply higher rates, inflation and the rotation trade (credit to equities) in full-swing? It’s not going to happen.

Remember, this is €23bn of corporate bond (thus far) which will not be coming back – they are buy-and-hold come what may. In 13 weeks, they have lifted an average of €1.76bn of bonds – euro-denominated corporate bond debt permanently removed from circulation (see chart below).

ECB Weekly Corporate Bond purchases

Weakness, but no capitulation

Brainard

Lael Brainard: Dovish words

The corporate bond market was closed for business, small wonder given the overall state of the market and we had nothing on the primary front. Equities fell 2% at the open but recovered some of their poise to claw back a portion of the earlier losses to end up to 1.5% down in the session.

That was helped by US stocks which were playing out in the black with gains accelerating after our close on the back of Fed governor Brainard’s more dovish words – the S&P recovering around three quarters of its losses from last Friday. Tuesday promises to be a better session in Europe.

Government bonds closed just off their lows for the session, too (in price) and yields ended only a touch higher, generally. German Bunds in 10-years were yielding +0.03% and much is made of the move into positive territory. We’ve already suggested that this will be short-lived – and the current moves are exaggerated because over extreme positioning. 10-year Gilt yields were flattish at 0.85% (versus a session high of 0.86%), while Spanish Bonos also closed flat (1.07%) and Italian BTPs managed some recovery off the session highs with 10-year yields at 1.27% (+3bp).

Corporate bond markets impacted too

After news of that shopping spree last week by the ECB, the corporate bond investors have good reason aplenty to feel relaxed about their market and just need to figure out how to work through their duration hedges (for total return players). Otherwise, it would just be too easy! We did end a little weaker, but we attribute some of that to Friday’s general weakness and to marks filtering though into today’s pricing matrix. The Markit iBoxx IG corporate index closed up at B+120bp and the first material reversal since the ECB’s asset purchase began some 13 weeks ago. In HY, the weakness was more pronounced with spreads on an index basis 17bp wider leaving it at B+428bp, but moves are naturally exaggerated owing to the greater illiquidity in this market.

bank of england

BoE: Getting in on the act

And finally, the Bank of England issued a circular around which companies will be eligible for purchase under its own QE programme. There were no real surprises (aiming to buy £10bn in total), except that a reverse auction process would be the way forward for them.

The net impact ought to be for sterling corporate bond valuations to be supported by the move, but we don’t think it will have a desired impact of much additional cash/liquidity/investment being channelled into the domestic economy (just like the ECB’s hasn’t done so).

It’s just potentially more cheap booty for corporate treasury desks, although once they have got their “general corporate purposes” fill in, they will also have to contend as to how to make a return on that additional cash. A quality problem, some would say. Anyway, credit spreads in this market also closed 2bp higher at Gilts+149.7bp (Markit iBoxx) – and the widest level in over a month. The index yields are a whopping 32bp higher versus the lows seen a month ago!

That’s it, back tomorrow. Have a good day.

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.