14th March 2017

It’s all about the Fed

FTSE 100
7,367, +24
11,990, +27
S&P 500
2,373, +1
iTraxx Main
72.5bp, +-0.7p
iTraxx X-Over Index
286.7bp, +3.7bp
10 Yr Bund
0.47%, -1bp
iBoxx Corp IG
B+131.1bp, unchanged 
iBoxx Corp HY Index
B+365bp, +0.5bp
10 Yr US T-Bond
2.63%, +5bp

The cycle is for turning

If the Fed dutifully obliges with a 25bp interest rate hike tomorrow as is likely, then given what we knew even only a couple of weeks ago, that first move this year will have come sooner than anticipated. The consequences being that while we have higher policy and market rates into an improving macro environment, we have weaker performance on a total return basis for fixed income investors.

That is what will matter – given the amount of cash that has moved into credit over the past several years looking for a slightly higher yielding, ‘safe haven’-like fixed income asset class. As we start this year, we’ve barely got much performance under our belts to play with and we’re not even a quarter of the way into it.

The rate increases should largely be priced into the market, so the moves ought not to matter a great deal. Investors should be aware and positioned accordingly.

Interestingly, of late, spreads have started to gain a little bit of traction in IG but it is the HY market which has been having a super time of it – the cash index some 50bp tighter in the opening 10-weeks of 2017. As we have stated in previous commentary, the high yield market carries a greater insensitivity to rate markets given the shorter duration nature of the asset class.  Allied with an improving economic outlook, corporate credit quality will improve disproportionately versus the IG universe. So, into the early stages of an upswing, the HY market should outperform – and we think this will be the case in 2017.

Inflows continue with aplomb into the asset class as suggested by recent survey data and this is backed up by the continued heavy demand for deals allowing borrowers to ratchet pricing tighter.  Guidance to final pricing for a typical 5-12 year maturity IG non-financial corporate offering can be of the order of 15-20bp (and usually is). Secondary has not been as welcoming in terms of spread tightening, but the last week saw around 3bp of tightening in the Markit iBoxx index – which is the best weekly move we have seen this year.

We will stick our necks out and suggest that these kinds of moves in both markets (and in secondary and primary) can continue. The credit market is a slow-moving beast and any major moves or changes in investor strategies usually take a while to filter through into the market and reality. Unless of course, panic sets in because of a serious financial crisis.

With that, we think that investors will stay the course for now, anticipate for low or even negative returns for the year depending on their credit class investment for choice and even continue allocating cash to the corporate bond market. As it stands, we’re looking for moderately tighter spreads from here, the same dynamic in primary and returns in IG to be slightly negative through the end of the first half of 2017.

ECB as reliable as ever

They’re up past €2bn last week and passed the €70bn mark overall. This week’s ECB announcement on its corporate bond QE interest showed that it had purchased an increased (versus the previous week) €2,085m of non-financial IG debt last week (see chart, below), taking their total purchases to date after 40 weeks to €70,428m.

We think that now might be the start of a phase where spreads are beginning to go meaningfully tighter even if the rise in market rates starts to dull performance from a total returns perspective. €70bn of debt purchases – a permanent extraction of bonds, and by default liquidity from the market – has to start having an impact at some stage. Now could be our moment.

Recent ECB weekly purchases

The total accumulated remains at around 10% of the eligible market and implies an average weekly grab of €1,761m of IG nonfinancial euro corporate debt since they began operations ten months ago.

Monday’s reflective markets

The market seemed in a reflective mood as we opened the week. Equities rose a little in a newsflow-light session (there’s plenty to come this week, though), while the rising yields in the government bond market was reversed a little. The 10-year Bund yield was a touch lower at 0.47% (-1bp), with OAT yields for the same maturity dropping 4bp to 1.09%. Gilts closed flat at 1.24% after an earlier decline on news that the SNP would be looking to hold another independence referendum.

In the credit market, the growing nervousness around rates and elections didn’t impact us. The primary market had several deals to keep investors occupied in an otherwise limited day. RELX plc printed a 2-tranche deal for €1bn in 4-and 7-year maturities, managing to extract 17bp of better pricing versus the opening guidance levels, for both tranches. The IG borrower was Statkraft with a €500m, 8-year deal 12bp inside the initial price talk. In senior financials, UBS issued €1.75bn in floating format. In sterling, American Honda issued a £350m 5-year deal.

Merlin Entertainments: Tapped their 2022 issue for €200m

The high yield primary market delivered a decent session, too, with Play Topco printing €500m (pricing Tuesday), Merlin Entertainments tapped their 2022 issue for €200m and Progroup clipped €150m. That’s an €850m session and takes the total for the month-to-date in excess of the €4bn mark.

In secondary, the market was barely changed in a very light session with reduced levels of turnover. IG credit closed a touch better for choice with the broadest measure for performance as seen through the Markit iBoxx index at B+131.1bp.

Sterling was a touch wider but the moves were minimal as one could expect for the opening session in any week. The high yield market was fairly unchanged with the iBoxx index at B+365bp (+0.5bp). On index, iTraxx Main was left at 72.5bp (+0.5bp) and X-Over at 286.7bp (+3.7bp).

Have a good day.

For the latest on corporate bonds from financial news sources, click here.

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.