7th October 2015

Back to the future

MARKET CLOSE:
FTSE 100
6,326, +27
DAX
9,903, +88
S&P 500
1,980, -7
iTraxx Main
84.5bp, -4bp
iTraxx X-Over Index
343bp, -19bp
10 Yr Bund
0.59%
iBoxx Corp IG
B+165.8bp, -2.7bp 
iBoxx Corp HY Index
B+525.5bp, -12bp
10 Yr US T-Bond
2.03%

We’ve been here before… Again we have weak macro reports (German factory orders, IMF economic outlook) which are suggestive of low rates for longer, more ECB QE keeping government bond yields pegged (or lower) and equities quite possibly sustaining their moves higher – should the Fed not move later this month, which is increasingly becoming the more likely outcome. That means all should auger well for the corporate bond markets given that it offers yield, safety (yes, they do) and hopefully a decent return. We’re taking baby steps at the moment into that possibility with a slow albeit selective grind tighter, which on the face of it doesn’t look particularly convincing. Nor should it be, truth be told. After all, there is still major event risk lurking around VW (now cutting non-essential investment) and the Glencore story has much legs in it. These two situations have been a good wake-up call for our markets in the sense that in the former, this kind of single-name event risk was completely unforeseen and difficult to position for in a diverse portfolio. For the latter, it is quite the opposite given the slowing in macro leading to the commodity cycle’s downturn. This resulted in a serious a hit on one of the largest exposed players around being inevitable. The method in the madness is for one to do their single name credit work, but also to cut/reduce exposures with discipline when the signs are obvious and growing against a particular borrower or industry group.

Baby steps to recovery could be short lived… On an index level, we might be seeing a laborious grind better just now, but should Q4 macro reflect ongoing concerns – and no economic catastrophe, then the bid for corporate bonds will see a 1-1.5bp IG corporate index (iBoxx) daily tightening in spreads turn into something a little more resolute like 2-3bp movements per day. Confidence has a habit of returning very quickly in our market and it will translate down to higher-beta risk quickly. At close on B+166bp (high B+171bp) for the iBoxx corporate index, we would think recovering September’s losses over the next few weeks (30bp) should be the first target to aim for. The weakness was predicated on low volumes and VW/Glencore event risk. We look for markets to gain much of it back. For HY, we are at B+525bp, having seen a high B+551bp just a couple of sessions ago, and could be around B+475bp before too long. Of course, liquidity or rather the lack of it works both ways and we accept that the ratchet tighter could be more measured than was the widening.

If confidence recovers, expect the new issue sluice gates to open… That’s always on the cards and cheaply priced deals will come first. Follow through performance will see to it that more supply, if not too onerous, feeds into a better feel for the market overall and those tighter spreads. There might be some who sell into strength, but it will be short-lived. Overall, little has changed, except that long term, the lack of a credible alternative to the current zero interest rate policy to boost sustainable growth will offer more structural concerns for the corporate bond market. That’s more a worry for later into 2016; for now, corporate risk still curries much favour. I am an unashamed bull.

Secondary showing modest recovery… Tuesday was a day which saw steady tightening pretty much across the board apart from VW. Nothing too convincing but better – and we’ll take that. High and low beta risk was bid-up tentatively amid balanced flows, and the sentiment was much improved. We’re a fickle bunch! VW cash was wider on those aforementioned headlines by up to 25bp, with we had the likes of Glencore and Anglo closing better by 30-50bp. Despite the good recovery in valuations and its equity price, Glencore is still trading cash at around 80c on the dollar. The iBoxx index in IG corporates was tighter at B+166bp and the HY at B+525bp. For iTraxx, we were similarly better, with Main at 84.5bp (-4bp) and X-Over at 343bp (-19bp). The US closed a small down with the S&P at 1,980 (-7).

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.