|iTraxx X-Over Index
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY Index
|10 Yr US T-Bond
History to repeat itself…
Corporate bond spreads and yields reached historical lows in March 2015, just before the ECB embarked on its original bond purchase programme. It was not lifting corporate bonds. Still, there was a euphoria about the corporate market, on the expectation that the scarcity of government bond paper would (eventually) force duration players into the corporate market. The grabfest saw the Markit iBoxx index IG corporate bond yield drop to 1.02% and the index spread tighten to B+94bp (see chart). That’s -35bp and -55bp, respectively, from where they currently reside.
However, this time we know that actual corporate purchases are coming from a price-insensitive ECB, but following the initial flurry of tightening when the announcement was made some 3 weeks ago, spreads have managed to only grind out a bit more. Index yields have done better, but largely because Bunds have rallied hard. The more limited spread tightening is not what we would have expected. For credit, we are aware that investor demand is high; there has been much issuance into it which hasn’t repriced secondary markets, liquidity generally remains poor and single-name event risk has waned. While similar to Q1 2015, macro remains extremely uncertain and we have some serious doubts about the level of GDP growth in the US (we didn’t back then) and Europe, while global growth expectations have been reduced quite markedly. It is almost like we are waiting for the starting gun to fire again, after a false start – but no one jumped the gun.
The ECB has squashed government bonds and the pips have squeaked all the way out to 9 years (negative yields) on Bunds, while most other markets have also benefited. We don’t think they will be able to lift much more than €2bn per month of corporate bonds out of the extra €20bn earmarked for additional purchases, and so the pips will squeak some more for government bonds – but also in the corporate bond market. We have to believe that the record lows in corporate yields and spreads will be tested.
The manipulative hand of the ECB
Best of the bunch
When it comes to performance, peer group comparisons always matter. Come year-end, the aim is usually to be perched in that top group. How to do it? First off, we’re all going to have a decent year if the projections are right – decent total returns or outperformance versus index. Playing the ECB, though, is what will likely make the difference this time. With that, we think confining ourselves to buying predominantly what the ECB announces as being its area of interest and then tries to lift would leave us in the second grouping.
The extra performance will come from buying what it can’t or won’t buy. We assume most will be long the paper that the ECB eventually transmits to the market. Related new issues will come richer as a result – and those corporates ought to be grateful. Normal market dynamics will ensure that investors will try and lift that paper anyway while when the ECB gets involved, they will buy and hold to maturity. That paper won’t re-emerge, in our view. It did with the BoE, but it only lifted £3bn – albeit from a much smaller market.
So, richly priced/valued ECB-eligible paper and/or the “other stuff”? We would focus on the “and/or”. That paper (non-eurozone domiciled corporates, high yield) will be relatively cheaper, have greater spread tightening upside, better breakevens; and one has a much improved chance of actually getting good allocation in primary – or just an allocation. We are still looking for spreads and yields, as measured by the Markit iBoxx index for reference, to reach the lows seen in March/April 2015. That’s an IG corporate cash index target of B+94bp/1.02%, versus B+149.5bp/1.31% currently.
Mixed week ends on a high
So we closed out on the front foot in a choppier week than we ought to have expected. There was volatility everywhere, except in the corporate bond market. Here, spreads edged a little better in the week, while we easily contended with some €13.4bn of IG non-financial issuance which had no repricing impact. High yield similarly held firm, although supply here was more limited and confined to a small clutch of borrowers. Still, the omens are good.
Elsewhere, oil was up, with Brent eventually ending at $42 per barrel though it did see a $37-handle in the week. Govies saw safe haven assets in good shape. The 10-year Bund yield closed out at 9bp, just 4bp off the all-time low. Peripheral risk was choppy and saw movement of +/-15bp peak to trough in BTPs and Bonos – more for Portugal bonds. BTPs ended at 1.31% (-7bp on Friday), for example. For stocks, daily moves of +/-2% are all too common, and their contagion impact on credit now seems confined to the synthetic indices. We don’t even tighten markedly when stocks are rocketing, as we are transfixed by the ECB.
News flow from the US will dominate this week as we focus on economic data and, more importantly, the first quarter earnings season. Consumer gauges and surveys will sit alongside the traditional earnings kick-off after the close today, with Alcoa due to report.
Have a good day.