1st March 2016

Beware the Ides of March

MARKET CLOSE:
FTSE 100
6,097, +1
DAX
9,495, -18
S&P 500
1,932, -16
iTraxx Main
99bp, -4bp
iTraxx X-Over Index
408bp, -13bp
10 Yr Bund
0.11%, -4bp
iBoxx Corp IG
B+185bp, unch 
iBoxx Corp HY Index
B+634bp, -3bp
10 Yr US T-Bond
1.74%, -2bp

How predicable was that?… We closed out February on a slightly weaker note, using lower Asian markets overnight as the initial driver for the caution while choosing to ignore that oil prices were higher in the session. Nevertheless, central bankers will be casting an eye on the super performance of the Swedish economy (4.5% annualised in Q4), which comes about after a prolonged period of deeply negative rates, while Denmark’s economy also recorded a jump in Q4 2015 after a sharp drop in Q3. Poor data once again from the the eurozone (aren’t we used to that?), with the region’s inflation rate for February dropping to -0.2% as energy prices continued to weigh (more than expected) while, more worryingly, stripping out energy the core rate fell to +0.7% from 1.0%. Simpletons and all will be looking at lower rates as the way forward, and the race to the bottom is on: the ECB next week is expected to move closer to the front runners. Other stimulus came from the PBOC as it again reduced the banking sector’s reserve requirements in order to boost credit expansion. The equity markets were choosing to look at it from the downside. Things are bad and we believe they’re getting worse, so to say. Stocks have ended the month on a downer and those returns we published yesterday will be little worse for the month/YTD. A leap into the unknown? It is safe to assume that’s what is coming. All eyes will be on the ECB from now until next week’s meeting and a 20bp cut in the deposit rate will be the least they could do, while expanding the asset purchase programme by €15-30bn a month will also be on the cards. The resulting lower and/or negative rates will just cost us more and will not work their way into boosting credit expansion in the right areas of the economy. Only a quarter ago, the Bund was the short of the century. It seemed an “obvious” trade, but now we’re back down to under 11bp on the 10-year yield (-55bp YTD) and just 6bp off the intraday low seen a year ago. We suggested back then it would go negative, and we are still of that view. The 2-year Bund yield recorded a new low, of -0.58%. In the big “will they, won’t they?” debate, the huge miss in the Chicago manufacturing PMI – which was back in contraction territory at 47.6 in February from 55.6 in January – leaves much food for thought for the Fed.

Stimulus is coming, again… The eurozone economy is not about to fall off a cliff. Achieving a long-term goal of a 2% inflation rate means more stimulus. We all worry about the Brexit vote and what it will mean if the UK decides to leave – or stay in, for that matter. There is just about zero by way of structural reform. What will it take? Pain, and no one wants that. So we’re in it for the hard slog and a multi-year weak economy is what we look forward to. More of the same, in effect. The downs will be greater and so we think government bond yields will continue to fall. While in these unchartered waters corporate bonds will resume their lure – or they ought to. 10-year German Bund yields at close on zero versus single/double-A corporate bond risk yielding upwards of 1%? We’re plumping for corporate bonds. The high/low beta compression trade might take a while to come back and need some convincing to put on – it was more than a flight-of-fancy in the 2012-1014 period, but now we’re not playing into low rates/yields and economic recovery. Now it’s a case of low rates/yields and mind the bumps on the way down. Still, corporate balance sheet integrity is as resolute as it has been through the crisis period, and deserves recognition. And it is coming through the primary markets, although supply levels could be better. Apprehension is in the secondary market, where down-days see better sellers and no bid and up-days better buyers and no offers. Stalemate.

Cash market gorges on new deals… New deals from BP and IBM kept the corporate bond market occupied. All the deals, 5-tranches for some €4.25bn, were tightened by an average of 15bp versus the initial price talk, illustrating the high levels of sidelined cash, investor confidence and demand for corporate bond risk. It is almost as if the weakness in secondary valuations is not the real story for the corporate market. Supply has now reached €23bn for the month, and €31bn year-to-date for IG non-financial issuance. The fact that most deals are performing will give a lift to the whole market and while secondary might not pull tighter on wider macro concerns, issuers and investors should take great comfort from the dynamic in primary.

Biting those fingernails… Certainly, as we close out February and those performance valuations start dropping through those mailboxes, corporate bond market funds ought to have little to fear in terms of potential outflows. Fixed income and oil have had a good month while equities have languished. The DAX is down 4% in the month or 9.5% YTD. Oil has played a blinder of late and seen some great recovery though February, down now just 3% YTD for Brent. It was down 2-handle percentage points at one stage in January. The rally in government bonds yesterday sees eurozone government bond market returns up at 2.6% YTD, while corporate IG has now returned 1%. Elsewhere, into the close, the iTraxx indices lurched lower with Main closing below 100bp and X-Over 13bp lower at 408bp. The cash markets closed unchanged and we refer you to our updated spread pages on this site.

May the markets be kind to you, however you are positioned. Back tomorrow.

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.