27th February 2020

😷 Bond investors self-isolate

MARKET CLOSE:
iTraxx Main

57.0bp, +6.2bp

iTraxx X-Over

257.4bp, +22.6bp

🇩🇪 10 Yr Bund

-0.55%, -6bp

iBoxx Corp IG

B+115bp, +5bp

iBoxx Corp HY

B+399bp, +22bp

🇺🇸 10 Yr US T-Bond

1.28%, -3bp

🇬🇧 FTSE 100 5897.76, (-1.54%) 🇩🇪 DAX 12313.36, (-0.54%) 🇺🇸 S&P 500 3271.12, (+0.77%)

Markets shell-shocked…

Fear is writ large all over the markets. And the corporate bond market is now under the same pressure as equities, as the global risk asset bubble deflates amid the coronavirus pandemic.

The bid side of the market has pulled right back and the already meagre flows in secondary have dwindled further, with sellers unable a get a decent price for any reasonable exit. That particular trading dynamic is understandably expected.

We suggest taking the current medical advice. That is, it’s time for corporate bond investors to self-isolate and quarantine positions until market volatility subsides. The best one can do here is to add some protection and sit out the market carnage.

IG spreads – iBoxx index – are a massive 15bp wider this week. The hitherto darling of the corporate bond market, in performance terms anyway, has been bullied out of its complacency. The AT1 index has recoiled by 95bp this week and the high yield index some 71bp. And there’s still a session to go. Illiquidity brings out the worst in valuations.

Economic activity has already declined sharply and there is likely more/greater falls to go before we reach some kind of endpoint and a recovery. What comes out the other side though isn’t going to be pretty. Macro will take an age to recover, we believe. Global macro was already creaking as China was slowing and the Eurozone was struggling to break free from the shackles of the decade-long slowdown.

That’s not to say there won’t be a sharp recovery of sorts in asset prices. The relief rally, when it comes – and if it has legs – could result in a significant push higher whereby much of the current losses are recovered. However, once the dust settles, the new normal will be somewhere in between what we have now and that record-breaking rally of early February. It’s going to be a tough ask to push on beyond that.

Thursday was another very difficult day. Equities opened sharply lower yet again. We were faced with 2%+ declines – at the open – in European equities, following overnight comments from Trump which failed to assuage the worst fears of the market.

Of course, it’s put the kybosh on the primary markets. Once again, we had nothing doing in primary. It’s temporary, as we will eventually resume business as normal and we don’t at all doubt that the demand for deals will be as strong as it has been these past few months.

There is cash still waiting to be put to work and in one sense there will be some relief that the new entry levels will be at wider spread levels. As such, we can expect any sense of control in the coronavirus’ spread would see a calming in equity market volatility, and to almost immediately follow with an opportunistic corporate borrower. And more normal functioning market would follow quickly.


Primary remains closed

So we have effectively closed for the month in primary. It is safe to assume that there is not going to be a corporate bond deal on Friday. It was an excellent start to the month but obviously events have since conspired to close it early.

Three weeks into February and we were looking at €35bn – €40bn being issued for the full month, but we have only had the single issue from Paccar in the IG non-financial corporate sector being the total for the month to €29.7bn. That’s still a solid enough of a recovery in issuance after a fairly light January where just €20bn was issued.

So in February, we had several triple-tranche deals from the likes of IBM (€3.75bn), Comcast (€3bn) and Dow Chemical (€2.25bn), while Siemens issued four tranches for €4bn and LVMH issued €7.75bn in. 5-tranche transaction. Many of the aforementioned borrowers also issued in sterling.

In the high yield market, the increased level of volatility and weakness in equities saw this market also close after three weeks, where the issuance run rate of €8.7bn was excellent and continued the great run of deals seeing January (€13.1bn).

Taken in isolation, it’s a record run rate. However, we think that the slowdown in macro and potential for a laboured recovery will hinder corporate borrowing plans as investor shy away from adding too much high beta risk (single-B or lower).

Of course, there is a fickleness in the investment process. Should authorities get a good grip in curtailing the virus’ spread, and we see a resumption in economic activity which avoids the worst – and contains the default rate (which will pick-up), then we might see a bolder investor add risk.

After all, the ECB is still hoovering up the IG market and crowding players out. That’s unlikely going to change, especially now.

After €31.5bn of issuance in January, we saw a considerable slow down in issuance (as expected) in February before the market shut with a week still to go, in senior bank deals. Just €11.5bn was issued and the €43bn printed year to date is still good going with somewhere of the order of €150bn still likely, market volatility permitting.


Pain increasing

Risk markets were again crushed on Thursday. Equities across Europe fell by 3% or more adding to the already substantial losses seen over the past week. The FTSE was hammered by declines of 3.4%, the Dax game up 3.2% and the €Stoxx50 some 3.3%. In the US, markets were down by around 2.5% as at the time of writing, in a very volatile session with the Vix up at 32%.

In rates, there was a scramble for safe havens which pushed US yields to record lows before edging off them, at the time of writing, with the 10-year Treasury yielding 1.28% (-3bp) and the 30-year 1.77% (-3bp).

In Europe, it was a similar picture although there is still 20bp or so to go before Bund yields see record lows, with the 10-year yield at -0.55% (-6bp) and the equivalent Gilt yield down at 0.46% (-5bp).

There were defiant words from Lagarde regards the prospect of imminent ECB action in response to the coronavirus, but one will come in our view. The economic impact will have the central bank’s economic team slash the region’s 2020 growth levels and a rate cut or two – and heavier QE purchases – will be needed.

Of course, we had the recoil in synthetic credit markets as protection was sought. Up the costs went with 6.2bp dded to Main moving it to 57bp and X-Over jumped 22.6bp to 275.6bp.

Cash likewise took it on the chin. The iBoxx IG corporate bond index jumped another 5bp to B+115bp which is 15bp wider this week in just four sessions. Total returns have edged only moderately lower as the underlying has rallied.

The AT1 index moved 34bp wider to B+441bp and total returns are in negative territory (just) year to date. As for high yield, much of the same, the index 22bp wider at B+399bp and total returns at -1.7bp year to date.

Have a good day.

Suki Mann

A 30+ 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 CreditMarketDaily.com.