24th February 2016

Brexit, bonds and opportunity

MARKET CLOSE:
FTSE 100
5,962, -75
DAX
9,417, -157
S&P 500
1,921, -24
iTraxx Main
108bp, unch
iTraxx X-Over Index
428bp, +4bp
10 Yr Bund
0.18%, +1bp
iBoxx Corp IG
B+185.4bp, -0.5bp 
iBoxx Corp HY Index
B+634.5bp, -4bp
10 Yr US T-Bond
1.74%, -1bp

To dare is to do… We’ve taken a look at how spread markets have reacted to the possibility of Brexit and the debate around it. First some numbers. As measured by the Markit iBoxx index, sterling corporate spreads have widened by 60bp to G+240bp while the euro-equivalent index has widened 32bp to B+186bp, both year-to-date. In sterling, some 30bp (half) of that widening has come in February alone, while the euro index has gone 13bp wider in the same period (40% of the widening). So the euro-denominated index has outperformed. Is that a big deal, and is the Brexit debate the root cause of the underperformance of the sterling corporate bond market? First, the chart below shows that the differential between the two indices has been wider, at 80bp in late 2011 versus 54bp now. The sterling bond market trades at a premium to the euro one for several reasons. It is much smaller, it is even more illiquid, it is controlled by a few very large players and the information ratio is much poorer. Issue sizes are smaller too, and the sterling market is a longer duration one (7.5 years versus 5 years). Amid the recent oil/commodity sell-off and the resulting equity weakness and volatility, we could and should have expected the sterling market to underperform (it did, slightly), but the Brexit debate has added a little fuel to that. So while the Brexit debate might keep spreads at an elevated level, we think there could be an opportunity to be had if the “stay in” vote ultimately wins out and one positions for it soon – there might be a better entry point depending on how the polls evolve over the next few months. At the moment, it isn’t a big deal given the aforementioned vagaries of the sterling market – but it could become one if the “leave” camp wins!

£ Corp (Index) underperforms vs € Corp

Brexit

Tuesday sours and oil is back on the radar… After Vodafone’s mega deal on Monday, we drew a blank in primary on Tuesday. The corporate sector went from feast to famine in a flash. Incredible! We would have expected borrowers to be champing at the bit to get some funding in, even if there was some moderate weakness for risk assets through the session. The new issue market saw just a few covered bond and SSA deals. Oil prices ended the day around 4% lower after the Saudi oil minister poured cold water on the idea of possible output cuts. The minister’s comment late in the session but not late enough to see stocks fall deeper into the red on the back of it, while the safest of government bonds barely moved. The Ifo index of German business expectations for February saw the poorest reading in 4 years, while a similar one in France offered much the same. Q4 German exports also fell, for the first time in 3 years. The pressure is building on the ECB and the euro took a hit on the back of it, dropping some more versus the dollar. Credit did very little. Even Deutsche Bank’s attempt to buy back €3bn of debt failed (or did it?), with less than half that amount tendered: at least it has managed to prop up Deutsche’s bond prices.

Here we go again… The DAX lost 1.6% with losses accelerating into the close and most other bourses followed suit. Oil was back in a $31-33 per barrel range for WTI/Brent. The Bund closed pretty much unchanged, while Gilts lost some ground, the 10-year yield up at 1.43%. Secondary credit saw its usual limited volumes and flows, but generally the market were very slightly better bid leaving the Markit iBoxx cash index a touch better at B+185.4bp in IG, and B+634.5bp in HY. iTraxx Main closed unchanged at 108bp and X-Over was 4bp wider at 428bp and both will likely open higher give the weakness in US stocks (-1.25%) after our close yesterday.

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.