Suki Mann

Author Archives: Suki Mann

9th September 2015

Just saying how it is

MARKET CLOSE:
FTSE 100
6,146, +72
DAX
10,271, +163
S&P 500
1,969, +48
iTraxx Main
71bp, -1.5bp
iTraxx X-Over Index
330bp, -5bp
10 Yr Bund
0.67%
iBoxx Corp IG
B+143bp, unch 
iBoxx Corp HY Index
B+466bp, -2bp
10 Yr US T-Bond
2.19%
Boring is good… Investing in corporate bonds was never meant to be an enthralling or captivating pastime. Yet we make it so, and over the past few years we have gotten all cock-a-hoop when greeted with a flurry of issuance. Poor secondary market liquidity means that the ability to trade (in size) at a reasonable price has been lost on us. So the scramble to get bonds on board in primary – the adrenalin rush which comes from winning a mandate, the high-fiving when IPTs are tightened up and the relief for borrowers that deals are launched without too much or even any altercation, is palpable. But really, it ought not to be that melodramatic. For investors, buying corporate bonds ought to be for the long term: buy, hold, clip the coupon and move on to the next deal. Yet they worry about liquidity, allocations, a basis point of movement on the break which might go against them. Event risk through M&A, releveraging and say jump-to-default ought to be the major structural worry. For regular borrowers however, the process has become somewhat mechanical, while the opening up of the corporate bond market since the crisis (central bank easing, low yields, copious liquidity) has created a depth and breadth where even non-frequent borrowers are now able to raise monies without too much fuss. The euro-denominated market is now a Eur2tn one, up from around Eur700bn some seven years ago. We have critical mass, and certain processes are becoming more mechanical. Syndicates play their part, but soon enough that role might possibly start to diminish. Time and more maturity will tell.

Up, up and away… Chinese imports may have fallen hard, but German trade figures dominated on the macro front giving the markets a filip to trade better. Equities in Europe traded up by over 1%, credit edged tighter and the iTraxx indices were better offered (lower). We had some issuance into the improved tone, although only Swisscom’s issue (A2/A) was of real note in the non-financial sector as the issuer came with a Eur500m, 10-year at midswaps+80bp (and a huge 15bp tighter than the initial price talk). Why bother with the huge initial premiums? After all, the demand is there, it’s not rocket science. And as mentioned above, with respect to less frequent borrowers able to get deals away, Finnish shopping centre group Citycon was on the screens for Eur300m of 7-year funding at midswaps+175bp (mid-triple rating), offering a decent 10-15bp premium.

Secondary spreads go with the flow… Secondary markets have seen much more limited activity for what seems like an age and this session was no different. Still, they delivered what we expected in line with higher equities. Spreads moved tighter. And so the week which began very modestly on the front foot continued with us edging very slightly better. It left the broader indicator of the market, measured through the iBoxx index, at B+142.9bp and barely better, but higher beta sectors did record some upside in Tuesday’s session. Once could argue that the machine has to slow – it has, and the FOMC is looms large.

8th September 2015

Labor Day respite over

MARKET CLOSE:
FTSE 100
6,075 +32
DAX
10,109 +71
S&P 500
1,921
iTraxx Main
72.5bp, -2bp
iTraxx X-Over Index
335bp, -5bp
10 Yr Bund
0.66%
iBoxx Corp IG
B+142.9bp, unch 
iBoxx Corp HY Index
B+467bp, unch
10 Yr US T-Bond
2.12%

Heigh ho, it’s back to work we go… Happy Tuesday! Labor Day in the US yesterday saw to it that the market would make no more calls on US rates to aid the uncertainty and volatility that have plagued us recently. Few were going to get involved in taking a view on ‘what next?’. Equities were nevertheless lively early on, despite China’s equity drop overnight along with the small matter of nearly $100bn leaving its huge FX reserve coffers in August – mainly because Glencore was selling assets to reduce its debt load. The news was very credit-friendly, as it included suspending dividends in the package. Tesco added to the credit-friendly news flow, announcing the sale of its Korean business for £4bn. On the downside, German industrial production data for July was a little lower than expected. The rally steadied and we were closing the session off the highs, and credit markets followed suit with only moderate upside. Secondary just edged a little better. We saw some primary activity in covereds, unsecured financials and even in corporates. Just to keep us all ticking over nicely.

Spanish borrowers dominate primary… Telefonica kicked off with a 6-year, Eur1bn issue at midswaps+98bp, while Spanish utility Iberdrola chipped in with an 8-year, Eur500m deal at midswaps+100bp in 8-year funding. New issue premiums were cut significantly to 8bp and 5bp respectively. Iberdrola’s deal was 8x oversubscribed! The deal was up on the break, but the 2x oversubscribed Telefonica deal was a touch weaker versus reoffer. Iberdrola got it right for investors, although they both got their funding in. Bank of America graced us with a couple of unspectacular tranches to populate the unsecured senior financial space. Amid all the noise around US rates, China’s slowdown and potential for additional action from the ECB leaving equities in particular volatile, the follow-through into the corporate bond market has been fairly restrained. Our market has not panicked at all and spreads have edged just a touch wider in the first proper week of post-holiday trading, while the new issue market has been flying. This level of macro uncertainty and volatility ought to have seen less supply. Instead, the level of activity in primary has confounded the sceptics, me included. Furthermore, it has been taken down very well, with most issues trading up versus re-offer levels. This augers well for the corporate bond market in Europe overall. For instance, smaller deals likely from the likes of Camilla, DLR, Pentair, Swisscom and Achmea ought to sneak through without too much difficulty.

Secondary quiet… Glencore paper was up to 80bp better but had been battered over the past few months into the commodity sector’s generally poor performance. Tesco paper was up to 5bp better. Equities were higher by around 0.7%, helping to support other markets and we managed to edge a little better in credit. 10-year bund yields moved a couple of basis points lower to 0.66%. Oil prices fell though by around 3%. At the close of last week, the iBoxx index lost 3bp in IG so today’s albeit modest tightening was welcomed, the index at B+142.9bp. The weakness in corporate spreads when we get it stems from the Street’s more defensive marks rather than being driven by any significant selling by investors. At best, investors are sidelined into macro/equity-induced volatility, and are better buyers otherwise, hence the bid for all things new issue. After all, there is scant liquidity elsewhere in the corporate bond market. This has been the pattern for several years and will carry on being so for a while yet.

7th September 2015

Stickin’ up for the little guy

MARKET CLOSE:
FTSE 100
6,042, -151
DAX
10,038, -280
S&P 500
1,921, -30
iTraxx Main
74.5bp,+2.5bp
iTraxx X-Over Index
340bp, +10bp
10 Yr Bund
0.67%
iBoxx Corp IG
B+143bp, +1.5bp 
iBoxx Corp HY Index
B+467bp, +3bp
10 Yr US T-Bond
2.12%

Favouritism, fear of failure or just greed… Alas, it looks like the authorities are finally in the process of addressing the issue of allocations in the primary bond market. This matters, because all manner of decisions are impacted by allocation – to hold, to flip, to buy more, as well as what the success or failure of a deal means for the current state of the market. But it goes further. The current process, broadly speaking, sees to it that certain investors – usually the larger players – can effectively guarantee the success or perceived failure of a newly launched offering, market conditions aside. They are able to take a sizeable chunk of most deals, as they have the highest absolute skin (money to invest) in the game. One could argue they bear the brunt of much of the risk if the deal does not perform, so it is only fair. That said, not long ago, as part of the pricing (and deal sizing) process, investment banks used go on a ‘price discovery’ exercise with a number of ‘important’ market participants, especially in the case of borrowers perceived as being more ‘difficult’, or in times of market stress. After all, no one wanted a failed launch. However, this price discovery process has disappeared, as investors do not want to be wall-crossed. Still, once the deal is announced conversations can take place.

Who’s looking out for the little guy?… The story goes something like this: after some marketing, putting the deal on the screen, building books and so on, the allocation process usually sees that the ‘big guy’ gets his bonds (or a decent percentage of his needs) – still. Usually, he has put in a sizeable order (maybe a so-called lead order), which can then sometimes be communicated to the broader market. Or leaked. Anyway, going back a step, the book-building process sees that the size of the book, as it grows, is somehow communicated. We note that for an SEC-registered deal, you cannot do an update on book sizes until after pricing. That is an obvious first step for the euro market. Anyway, the ‘little guy’, fresh with this bookbuilding communication/information and not wanting to get left behind, then piles in. He is not going to be the mainstay of the deal’s success or failure, and a final allocation will usually see him get less than hoped for – or nothing. Therefore, he more often than not inflates his order, playing into the hands of the banks who herald the tremendous demand for the deal. So the book builds some more and other orders – usually inflated – follow. Voilà! A Eur500m deal is for example 4-5x oversubscribed, but the ‘real’ demand is actually much lower. Who cares? The borrower gets his funds and pricing is nearly always better than the initial price talk (IPT). Happy borrower. As for syndicates, we agree they only publish actually book sizes which are derived from client orders – concerned at the Market Abuse Directive (MAD) – and will not mislead the market. But they happily take inflated orders, take on no risk through this process and pocket their fees. Happy banks. The ‘little guy’ is left frustrated as the issue is launched, is free to trade, might trade up or down, and he has no control – and usually only a few bonds. Who cares? We move on to the next deal.

And the rest – well, it gets interesting… Manpower (Baa1/BBB) slipped in a deal ahead of the NFP numbers at the end of last week, confounding most that Friday would be a non-event. Mind you, the deal was only for Eur400m (on a Eur1bn book), so not in the benchmark, although it seemed reasonably priced before being tightened to midswaps+125bp (-15bp versus IPT) for 7-year funding. Away from that, equities chose early on to give back their gains of the previous session, and then gave back some more following the good but lower-than-expected payroll of 173,000 jobs added in the US (unemployment rate down to 5.1%). That’s effectively full employment in the US and an average run rate of over 220,000 jobs added in the last 3-months after revisions. The market now thinks a hike is coming in a couple of weeks, hence the ratchet lower in stocks (S&P -1.5%, Dax -2.7%). And it gets interesting now with a potential tightening of monetary policy in the US and room for loosening in Europe. The fork is skewered as we head in different policy directions. Until we get that Fed decision on the 17th, the markets are going to remain very edgy, while EM fund outflows could possibly accelerate into it. They certainly won’t slow. The likely defensive nature of investor dynamics/sentiment over the next two weeks will leave stocks volatile – the front of the US Treasury curve might see some weakness while the back end stays fairly anchored. In Europe, we will decorrelate from the US as govvie yields play to the tune of the data in the eurozone and potential for additional accommodative ECB policy. It’s a decent data week ahead as well, with trade and inflation numbers from China, and industrial output and trade figures out in the eurozone. The US is closed for Labor Day on Monday.

Finally for corporate bonds… We’re not going to ratchet tighter as far as spreads are concerned because macro uncertainty and equity volatility will act as inhibitors, but we should hopefully gain some performance. We closed a little weaker in corporate bonds across the board at the end of last week, the usual higher beta sector under most negative price action (CoCos and hybrids), with only the new issues really managing some obvious performance.  We expect Europe will outperform the US in spread and absolute terms. Higher rates in the US possibly leading to higher yields will eventually eat into returns, for example. Euro-denominated credit will continue to benefit from low(er) yields while demand for corporate risk is going to stay robust in the face of a continued low-yielding environment and a need for a higher yielding, safe-haven investment.

4th September 2015

That was the week that was…

MARKET CLOSE:
FTSE 100
6,194, +111
DAX
10,318, +270
S&P 500
1,951, +2
iTraxx Main
71bp, -3bp
iTraxx X-Over Index
330bp, -8bp
10 Yr Bund
0.72%
iBoxx Corp IG
B+-142bp, +1.5bp
iBoxx Corp HY Index
B+463bp, +3bp
10 Yr US T-Bond
2.16%

Thank heavens for the upcoming non-farms report… Because it brought the opening week of the post holiday period to a much needed albeit premature end. Friday will be a non-event, with moribund markets – as few will want to do much ahead of the US payrolls report later and will be pondering their moves for next week. There will be much to reflect on with those payrolls and it could be a nervy week to follow depending on the number. Market participants in all asset classes will be sidelined today, so expect a quiet session after a fairly edgy start to this opening week of September. The Fed actually has its work cut out whatever the figure, needing to look at the global situation as it reflects on the right course of action to take on domestic rate policy. My view is that there should be no rate move. Markets are global, and that huge interconnection now between them means that it will matter, possibly, what they do. If they raise rates at the next meeting in mid-September, the language of the subsequent communique will determine the level of market volatility, the reaction of the different asset classes, fund returns and which is going to be the best asset class to be in. If the language is soothing, any rate adjustment higher will be greeted with a potential rally, treated as a damp squib and we’ll have a good run into year-end. The threat of more hikes in subsequent meetings will likely offer us more volatility and the need for a more defensive attitude through to the end of the year. Simple, really.

Accor giveth with right hand, taketh away with the left… We were not disappointed from today’s new issue activity with Suez (A3), Accor (BBB-), Honda (A1/A+), Heineken (Baa1/BBB+), Scania (A-) and Kerry Group (Baa2/BBB+) providing the fill for us today. The demand was ‘very good’, with books 4-5x oversubscribed in most of the deals. Heineken raised Eur500m in a no-grow 6-year at midswaps+70bp, Suez raised the same in a 10-year transaction at midswaps+80bp while American Honda plumped for a dual tranche 3.5-year floater and a 7-year fixed at midswaps+75bp. Scania’s was a short-dated floater, and sub-benchmark to start with, but they managed to raise Eur500m. Kerry’s deal (Irish foods group) was an inaugural, brave 10-year at midswaps+137bp for Eur750mn. Accor gave with one hand and took away with the other. They paid up for a tender of the 17s and 19s (around 30-35bp) while offering a concession for the new 8-year starting at 40bp. They settled at midswaps+155bp for Eur500mn (25bp premium). Initial premiums went out in the range of 17bp (Heineken) to 40bp (for Accor). They ended in the range of 7-20bp. More on this on Monday.

Monetary policy focus on more stimulus in Eurozone… No action from the ECB – but that is not news. The news was the potential for further accommodation (on growth and inflation concerns) and Draghi’s dovish stance which gave equities an additional  boost. There were hopes also that the Fed will be kind to the markets later this month. Basically everything we need to keep equities supported, corporate spreads tighter and a broad risk-on environment! It’s like the good old days. European equities gained by 2-3%, oil futures edged up a little, govvies were better bid and credit stable’ish amid still relatively only moderate secondary flows as primary markets dominated. Recent deals are performing well and this is seeing some confidence return to our market.

The US stock market rally faded after the close in Europe, so expect little to happen today as a follow through. As for the Thursday’s session, the iTraxx indices saw Main better offered, down at 71bp (-3bp) and X-Over at around 330bp (-8bp). Cash moves were more limited in a fairly unspectacular session and left in a narrow trading range, leaving the IG iBoxx index at B+141.5bp (+1.5bp) and the HY component at B+463bp (+3bp). The bund rally on a dovish ECB saw index yields lower and the first week’s marks of September seeing returns for corporate bonds on the up. Small mercies.

And finally, thank you… The iBoxx IG index is up at B+141.5bp and our straw poll asking our website readers where it would end at the end of the month from a starting level of B+138bp (end August) had them vote for a bullish stance. 55% expected spreads to be closer to B+130bp versus 45% who thought nearer B+150bp. After Draghi yesterday, the ball is in the Fed’s court. A thank you to all those who took time to vote.

Have a good weekend…

3rd September 2015

Pile ’em High & Sell ’em Cheap

MARKET CLOSE:
FTSE 100
6,083, +25
DAX
10,048, +32
S&P 500
1,948, +35
iTraxx Main
74bp, unch
iTraxx X-Over Index
340bp, unch
10 Yr Bund
0.78%
iBoxx Corp IG
B+109bp,unch
iBoxx Corp HY Index
B+460bp,+2bp
10 Yr US T-Bond
2.19%

New issue market bluster… Now we are all settled back in our seats, the focus is on that new issue market and how much paper we might expect to emerge in September and through the final quarter. We’re not risk-off in corporate bonds – far from it – but uneasiness around the macro outlook will see equity and rate volatility follow through to the credit market. It’s worked out just like that in secondaries, where trading volumes and flows have been light, but investors are still looking to add risk and as usual, the first port of call is primary.

Why? Sheep. That is, because everyone else is doing it and the safety-in-numbers mentality wins out, leaving the bid for primary intact. The macro-induced volatility might curtail some of the volume and timing of the supply of paper throughout this testy period, but issuance will emerge whenever that window opens, however brief. I will come back to issuance dynamics, technicals and volume expectations later. For now, the start to the post-holiday period has been difficult on macro and weak for equities and has got all manner of market commentators pondering the near-term future. For us in the corporate bond market, it’s a case of “gimme some lovin’ (paper)” as the new issue sluice gates threaten to burst. Today, we had a very good session for supply with the usual decent level of covered bond deals but, more interestingly, several non-financial issues. Toyota’s dual tranche Eur1.5bn was very front-end (2-year and 5-year) – and cheap, with a 10bp premium at midswaps+50bp for the 5-year; Schneider opted for an 8-year Eur800mn deal which eventually came at midswaps+70bp (10bp NIP), while French REIT Icade opted for a Eur500m, 7-year and an initial NIP of some 30bp, becoming 15bp at midswaps+125bp. We could expect a busy Thursday ahead of those non-farm payroll numbers given the impact a big number might have on markets (rate hike talk) and sentiment through next week.

Secondary markets again took bit of a back seat as we suggested they might, above; stocks in Europe also offered little, but respite and stability was all that is needed right now. European bourses were in the black (+0.5%) while in the US, the S&P500 clawed back around 1.8%. Govvie yields backed up some though, while the iTraxx indices played out in a tight range barely changed from the previous day’s closes. Main was stuck at around 74bp and X-Over at 340bp. IG low beta was unchanged to perhaps a touch wider, but higher beta risk – CoCos and hybrids managed to see good interest and prices moved a little better in the session – up to 0.375 points.

US borrowers to pile ’em high, sell ’em cheap?… According to data from Dealogic, euro-denominated issuance from US non-financial corporates is already at a record Eur47.6bn to end August ($60bn), more than double the $29bn printed in the same period in 2014. That’s 26% of the total market for this year so far, beating the 20% we saw in 2007 and set against a medium-term average of around 14-15%. What happens next to US rates and the Treasury yield curve will have a considerable bearing on how much issuance we see from US borrowers in these final few months of 2015. The lower-yielding environment in Europe has been a huge attraction for US entities, and they’ve clearly taken advantage of it. Going forward, this matters because they’ll pay up to get deals away – they will have to, given the poorer performance of the deals printed earlier this year. This will leave investors looking to extract greater new issue premiums as a way of trying to ensure some performance upside on the follow. The net effect of this will be that unless the stars on macro are well-aligned, it might put some moderate pressure on secondary spread levels across the market.

European corporate issuance to gather pace… Over here, European non-financial corporate new issuance had been running at a very high rate and we were heading for 2015 being a record. But the Q2 wobbles put paid to that, though still leaving us with a second best (end-August) level of Eur186bn versus a full-year record in 2009 of Eur285bn (2009 was Eur225bn to end of August), taken from data supplied by Dealogic. We don’t envisage we’ll get to that record level because there are effectively only three months of business left given the traditional slowdown through December. However, after Eur105bn of supply in Q1 (March alone accounted for Eur41bn alone), the months of June/July and August offered a measly Eur10bn, Eur11bn and Eur5bn respectively. The HY market has curried much favour in this low rate/yield/default cycle, with 2014’s record supply of Eur57bn (Dealogic data) probably not under too much of a threat given the more cloudy macro outlook and contagion from the US HY fallout as commodity prices (oil) sink. We’re currently up at Eur44bn. I would think that Eur240-250bn is a reasonable target for IG supply this year, and somewhere in the order of Eur55bn in the HY market. US borrowers should not be shy coming forward, but as a percentage of the total non-financial issuance they ought to drop to closer to the 20% mark.

2nd September 2015

Halcyon days over, but fear not

FTSE 100
6059, -189
DAX
10,015, -244
S&P 500
1,914, -58
iTraxx Main Index
74.5bp, +3bp
iTraxx X-Over Index
339bp, +16bp
10 Yr Bund
0.79%, -1bp
iBoxx Corp IG Index
B+140bp, +2bp
iBoxx Corp HY Index
B+458bp, +7bp
10 Yr US T-Bond
2.17%, -5bp

Resolute corporate bond markets… Into chapter nine of twelve and a difficult start. As ever, stock markets took the brunt of the risk-off trade with equities down by well-over 2%, oil futures moved lower some (-8%), the euro currency was bid-up while govvies only edged better. In all, it is actually a fairly exciting start to September. The newsflow centred on poor China PMIs that made for the defensive opening session of this new month. The IMF’s Lagarde threw her tuppennies worth in, warning of slower growth (again), while the data elsewhere was mixed to largely disappointing. It wasn’t quite the welcome back we wanted or needed after a choppy August. Still, no one told FIG borrowers as we were greeted with a smattering of covered bond and senior unsecured financial issuance. In a sense, the corporate bond market is continuing its merry way; the difficult macro arena these crisis years allowing it safe-haven like status (see below). Cash is king for them too. It will stay that way. Sustainable growth will be our bête noire, so we worry little. Corporate cash spreads will stay a little pressured nevertheless in these down sessions, with iTraxx indices being credit market participants’ principal tool of taking a view on equity volatility and macro event risk. The new issue market might slow with ‘odd’ deals sneaking through in periods of calm.

Sentiment remained sanguine given the quite decent primary market activity today. In the market, senior FIG deals saw Lloyds (7-year), Toronto Dominion (5-year floater) and CIBC (2-year floater) offering around 10bp of premium to get deals away. SSE (A3/A-) served up a transaction for the non-financial corporate sector, opening up the post-holiday season with a benchmark 8-year deal at midswaps+93bp, and a final 13bp NIP. Focus of the market seemed to be split between the new issues and the headlines/equities. Here, the tumble in equities left, for example, the DAX flirting with 10,000 again (-2.4%), the S&P almost 3% lower but we saw only a moderate flight-to-quality uptick for defensive govvies. The credit market’s proxy for risk off/on saw iTraxx Main up at 74.5bp (+3bp) and X-Over at 339bp (+16bp) in the synthetic arena, while cash was more resolute. No panic, little flow, low volumes and only moderate weakness. High beta saw CoCos off around half-a-point as were the corporate hybrids with low beta paper holding steady (+1-2bp). The iBoxx index closed higher at B+140bp for IG and B+458bp for HY, although month-end index composition changes accounted for some of the rise in index spreads.

Corporate bond fundamentals supportive… Fundamentals for corporate bonds remain in decent shape into all the brouhaha generated by the extended period and volatility around the macro situation. Global M&A has been on the up and loan margins have been declining, traditionally leaving many to look at this dynamic and fret. However, it appears they are not. We are actually more concerned with macro-economics/fund flows and not corporate credit fundamentals. After all, higher M&A in traditional industrial sectors should set the alarm bells ringing in terms of where we are in the (re-leveraging phase of the) cycle. But the manipulation of interest rates by the central banks over the past seven-or-eight years (and even buying of equities by the Chinese authorities!) have left us with little to fall back on in terms of historical precedent. That’s because there isn’t one. And it means we need to grapple with where we are in the cycle – we are a little blind here. It’s fair to say that corporate re-leveraging having a material impact on corporate credit quality in the broad industrial sector – in Europe, is not happening. And we don’t need to make any serious portfolio switch from a non-cyclical positioning to a more pro-growth cyclical one – or think about some sort of (clever) hedge to protect against M&A event risk. I think that dynamic is far away to start worrying.

As the economy continues to splutter… That’s because the global economy is spluttering mainly on China’s slowdown (but on many other structural issues too), while the potential for and timing of higher US rates concerns many. Greece’s woes are still lurking, oil futures and other commodities remain under pressure and we have all manner of geopolitical concerns to grapple with. Amazingly perhaps, there’s no sign of a sustainable recovery (today’s better-than-expected improved unemployment numbers notwithstanding) in the Eurozone despite a weak currency, low oil prices and rock bottom rates. Small wonder (European) corporates continue to hoard record levels of cash, that investment/capex spending has barely risen and defending current credit worthiness remains utmost. The ability to service those obligations into an uncertain Q4/year-end will stay the main support factor for corporate bonds. The attractiveness of other asset classes might become more of a competing issue for the corporate bond markets through 2016 – if growth shows signs of sustainable upside. Fat chance of that as we survey the outlook right now. It hasn’t been the case for several years, but we will need to review the environment (macro, rates, geopolitics) on a continual basis for clues that it might.

Higher beta risk still worth a look at… I think a stance towards that higher beta portfolio positioning is still the way to go in Europe. There’s some protection against higher rates (or rising yields) and why not clip higher returns and coupon income in what is still a low yielding environment? Corporate balance sheets are going to stay very defensive. The default rate is only ticking higher but at 3% or less, with little or no economic growth, that’s a very low level. You will get your money back in most cases; it’s just a case of staying out of the weak single-Bs, keep invested in the solid ones and pretty much double-Bs. Peripheral risk still works too, banking sector recovery means bank capital product does as well, while the 7-10 year part of the curve (slightly longer than benchmark duration) is also attractive as the back-end stays anchored. Quelle surprise, I still like risk.

Benchmark and absolute return funds have felt the heat… Looking at how the iBoxx index as a proxy for how spreads have moved this year we see some large moves, but on low flows and poor liquidity, hence spread moves have been exacerbated. Starting at B+111bp, the IG corporate bond index (iBoxx) has been as low as B+95bp and up at B+142bp, now settled at B+140bp. The yield of the index has been more interesting starting, low, high and now looking like 1.33%, 1.06%, 1.87% and 1.80%, respectively. That is, macro concerns pushing the underlying (bund level) have been the major yield driver. Wider spreads and higher corporate bond yields have therefore adversely impacted benchmark and total return players. Short-term weak global growth dynamics might help to keep underlying yields anchored or edging lower; while sustaining demand at a good level for corporate bonds thus offering support for spreads. The picture for the corporate HY index (iBoxx) has been similar with the index starting the year at B+435bp (4.41% yield), seeing a low of B+371bp (3.69%) and a high now at B+458bp (4.79%). Returns here have been in positive territory owing to the shorter duration of high-yielding bonds and thus the index, where weakness in underlying yields at the front end has been very limited – or there hasn’t been any. The 2-year bund yields a lowly -0.21% after all, for example.

The halcyon days for corporate bonds might be over, but fear not… The low hanging fruit may have been picked, with those now wild party-days for corporate bonds coming to an end. But one should still take the highest-beta positioning their risk tolerance allows; there is coupon income to be had, safe in the knowledge that the potential for a default over the next 3-4 years should be minimal. While I still like risk and prefer a higher-beta position, I would maintain a slightly higher-than-your-average cash position at the moment, too. That’s not because I expect material fund outflows. Quite the contrary. With the US rate move (possibly) imminent, there are going to be some portfolio shifts, and with it opportunities to pick up (cheaper) paper. Time to go shopping…

1st September 2015

The Cold Turkey Treatment

MARKET CLOSE:
FTSE 100
6248, +56
DAX
10,259, -39
S&P 500
1,972, -17
iTraxx Main
71.5bp, unch
iTraxx X-Over Index
324bp, -2bp
10 Yr Bund
0.80%
iBoxx Corp IG
B+139bp, unch
iBoxx Corp HY Index
B+454bp, -4bp
10 Yr US T-Bond
2.21%

The fat lady readied her voice… “There were ten in the bed and the little one said roll over. So they all rolled over and one fell out.” Oil futures were first to go. “There were nine in the bed and the little one said….” Chinese growth wobbles came next. You get the gist of it. Asian FX, then global equities, high yield credit spreads in the US, most commodities and so on. They have all fallen out of bed through a quite tumultuous second half of August. Lest we even mention Greece. When it rains, it occasionally pours. Seasonally poor market liquidity and fewer market participants have exaggerated the moves from a pricing perspective, and on the poorest of volumes. But let’s not blame that – confidence is shot, and faltering Chinese growth is finally coming home to roost. The ructions in the market caused by it gave us all that cold turkey treatment. It hurt. There’s belief in many quarters that going cold turkey actually makes addictions worse. So the Chinese are adding back some stimulus, but the patient’s response is going to be more limited. It is like that last bit of hope that the authorities have left; and it won’t work save for a short-term prop-up. We will need to get used to a world where growth rates are going to be materially lower than what we have been used to – and revalue risk assets and returns accordingly. After all, with oil prices hovering around multi-year lows, input costs falling, wage growth subdued, no inflation and yields at very low levels, we should be booming. We’re not.

Rates on hold everywhere… Nonetheless, all is seemingly good again at the moment. We’ve rallied quite hard and are off those lows pretty much everywhere. Still, the big decisions are yet to be made: the Fed ought not raise rates in September (likely not even in 2015). The BoE isn’t going to do anything either for a while, and the ECB might have to expand/extend its own Eur60bn monthly asset purchase programme. After all, the much watched 5yr5yr forward rate for inflation expectations is likely going to start falling again. We will hang on, hoping that any additional stimulus will work, just like we have been over that past 6-years. Hence the recent ‘dead-cat-bounces’ in asset prices. But China’s slowdown (and future lower growth rates) will have a more lasting impact on asset prices. I think we’re already into global deflationary territory leaving credit, in Europe anyway, worth its weight in gold for a while longer. Capital preservation is utmost and stays the modus operandi of the investment process. How long, will depend on the play off between those deflationary forces and the growth dynamic. For the moment, the ability for corporates to service their obligations is intact and remains the best it has ever been. But we should be prepared to accept lower returns for a while longer.

Environment supportive for corporate bonds… Therefore, and relatively, credit (corporate bonds) will hold its own against other classes for the foreseeable future, and we don’t see that there has been any sign of panic amongst investors in the corporate bond market in Europe. Concern, of course, as returns fall into the red. Interestingly, the threatened wholesale US shale gas E&P default hasn’t happened (yet), and yet HY has been battered with some weakness in Europe too. We think any emerging weakness in European HY and IG ought to be seen as an opportunity. That is, the spiral of contagion has unleashed some good entry levels – and that’s how we in the credit market should view it. Little has changed for us in European corporate credit, in terms of localised fundamentals. The Eurozone economy is barely growing, rates are stuck here ‘forever’, yields will stay low and corporate balance sheets defensive. ‘Twas ever thus.

Additional support for corporate bonds will come from a still low default rate as corporates now benefit from those defensive balance sheets, jam-packed full of cash that has had nowhere else to go for the past few crisis ravaged years. Raised at record low costs, financing burdens are anything but onerous. We still have work to do, decisions to make. But there is no need to panic, pull the trigger and bail. It’s time for reassessing and looking at the market with some pragmatism following the summer break. Most other markets have seen this year’s gains wiped out – and more, in a flash; corporate bond prices have been up and down like everything else; but we have regular income and, if in it for the long term, a buy-and-hold strategy will see principal repaid in full. Clip, clip, clip… that coupon.

Little real panic in the corporate space… The alternative to corporate bonds? In the ‘risk-free’ space, those filling the ECBs coffers with government bonds are subsequently prepared to park the cash with depository banks and are paying more and more for the privilege of doing so! Really, they are. Outflows from corporate bond funds in Europe have actually been muted. Illiquidity and lack of an alternative safe, liquid value-asset might have something to do with it. The bund has whip-sawed hitting a yield of 5bp (10-year) earlier this year and been up at close on 1% earlier in the summer; only to drop to yield a still paltry 50bp+ more recently on flight-to-quality flows (around 73bp now) and of course, ECB buying. Flight-to-quality flows have also seen the front-end well supported, the 2-year yield now at -0.21%. Corporate bond spreads have backed-up too, the iBoxx corporate bond index is 28bp wider now this year, having been 20bp better through a glorious Q1/2015; but the weakness in spreads has been less about panic, and more about a revaluation/illiquidity into that maelstrom of headline-driven event risks and copious levels of cheaper US borrowers’ paper.

Corporate bond love-in set to resume… So what happens next? Well, we wait and see to start with in these opening post-holiday sessions. Few will look to reduce risk – because they’ll fear that they won’t get the bonds back if need be (sell ’em and one will almost certainly kiss ’em goodbye). That is, the lack of secondary market liquidity might just be coming to the rescue of corporate bond valuations. And secondary market liquidity remains a shocker. Credit spreads have gapped in both directions because dealers aren’t bidding on much (or bidding to miss and thus setting the next lower clearing level) but are refusing to offer much either (on any upside), thereby keeping the market parched – and exacerbating price movements. No one wants to be left holding the baby. That dynamic will hold, until the growth and interest rate axis shifts against corporate bonds. That will be a while yet. As for Greece, she has become bit of a sideshow, but has managed a stay of execution; otherwise, without doubt the speculators might have headed for Portugal. And drilling down, is Portugal sovereign-risk safer than say, an EDP issue; or for that matter, is it better to be in BTPs (Italian govvies) than say an ENI or even TI bond? ‎I’m with corporates.

Slimmer pickings, but safety and income must come first… For corporate bonds, we might expect slim pickings on the new issue front early on. The US corporate bond market has been extraordinarily quiet. As we roll into the September, we need the stars aligned to coax borrowers out into the open.‎ That said, Merck KGaA pulled the trigger on a 3-tranche deal last week, but the Eur2bn offering was very cheap. It had to be, as syndicates (and less so the borrower) needed the deal to get away smoothly and with little altercation. For instance, before tightening up the longer 7-year tranche by 12bp, the new issue premium (NIP) was a significant 30bp! And the high triple-B/low-A borrower is viewed as a good name, ideal for this jittery market. Demand was skewed to the front-end as one could expect in these opening skirmishes. Anyway, we were running with new issuance close to a record rate, but it came to an abrupt end through that second quarter. Resumption – or a return to normality after the summer break will come, but only when we see calm on the macro front (not uncertainty).

Spreads? They’ll likely stay in range-bound fashion early on with the iBoxx IG index now at B+139bp. Targeting B+115-120bp into year-end is reasonable, but I can’t see it getting much tighter than that. For HY, the numbers show that spreads are also wider (iBoxx index, B+458bp), but returns are up at 1.5% (anchored front-end yields and a shorter duration asset class). The default rate at below 3% looks sustainable for a while yet, while it will may tick up in the US on the back of oil/shale gas related borrowers going to the wall; but even so, confidence in this asset class in Europe is with us for a while longer. We still get the impression that investors prefer higher beta risk, and believe going down to low double-Bs without too much homework should be do’able. The CoCo bond market is still worth a decent exposure to. The risk to all this is how China plays out over the next several months and the contagion impact any further downside/event risk might have.

Let’s be careful out there….

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