22nd July 2019

Capital appreciation, negative yields…

MARKET CLOSE:
iTraxx Main

58.7bp, -2.1bp

iTraxx X-Over

249.1bp, -3.1bp

🇩🇪 10 Yr Bund

-0.34%, -2bp

iBoxx Corp IG

B+116bp, unchanged

iBoxx Corp HY

B+419bp, unchanged

🇺🇸 10 Yr US T-Bond

2.03%, -2bp

🇬🇧 FTSE 100

7324.17, (-0.80%)
🇩🇪 DAX

13253.75, (-0.38%)
🇺🇸 S&P 500

3096.63, (-0.05%)

The trend is your friend…

An ever-increasing number of corporate bonds are falling into negative yield territory – or offering ever-declining (positive) yield for the rating, with the low hanging fruit just about picked off. With policy easing around the corner, the juice is coming from capital appreciation. The corporate bond market is seen as being a defensive investment (protecting capital) and comes amid little guarantee that traditional capital appreciation strategies (long equities) might be too volatile to pay off going forward.

Fixed income asset prices are rising so rate markets still work (yield becomes increasingly irrelevant) and asset allocators will retain their exposures. We would argue that credit has had its best ‘unassisted’ run in performance since the crisis began and looks set to add to it through the rest of 2019. IG credit sitting on 6% in total returns (iBoxx YTD) is looking at 8%+ come year-end; the AT1 market possibly 13%+ (10% at moment). Eurozone rates have already returned 7% this year!

We can reset the performance clock at year-end and worry about the meagre returns likely for 2020 then. Because the magnitude of the current returns/performance are clearly unsustainable. So we ought to be looking at the slimmest of pickings for 2020 (and likely beyond), and most likely negative/flat returns.

The big reset, however, can only come if we get a major sell-off in rates, credit will follow (spreads gap) and capital appreciation strategies will win out as we see an aggressive bid for equities. Alas, there is no sign of a return of a sustainable growth dynamic that would provoke such a scenario.

Ahead of the next central bank easing phase which is pencilled in to come by the Fed at the end of this month with the ECB also expected to offer something – if not at the 25th July meeting, then in the September one, we are not quite seeing the squeeze in credit spreads that we anticipated. The lack of activity isn’t the culprit, given that secondary market liquidity has been in some kind of  ‘parched’ territory forever, it seems. It’s simply because the current investor participation rate has dropped owing to the holiday season.

Rate cut/QE coming?

However, we can expect a renewed vigour for credit risk once we’re up and running again at the end of August, whence we might just be welcoming a lurch lower in underlying yields following a rate cut in the US and the market expecting similar action or more (QE) from the ECB.

The first signs of that will possibly come this week with the ECB expected to make some sort of signal that a rate cut is coming as well as the likely resumption of QE – at some stage in the near future too. Those are the very least that the market is expecting.


Activity slowing

For now, the earnings season is up and running and offering a mixed bag of results which are leaving equities to trade in a narrow range. The Iran/UK/US conflict could spiral out of control and is probably directly responsible for the better bid we have for safe havens at the moment.

For this week, the focus is obviously not the ECB but we also have a new prime minister in the UK, with Boris Johnson expected to be anointed by the Conservative Party on Tuesday as Theresa May officially steps down on Wednesday. And then begins a summer of intrigue around Brexit and a huge amount of excitement about how the new UK tax/spend/various regulatory regimes play out as the new government sets out its stall.

In credit primary, the market is not closed and we are seeing opportunistic deals where the trickle of offerings could continue for a few more sessions.

In the IG non-financial market, FedEx was back for its second visit to the euro-denominated debt markets this year, this time for €1bn in a 2-tranche deal split equally between a 6-year offering (midswaps+70bp) and a 12-year at midswaps+110bp. The final pricing reflected a 30bp tightening versus the initial price talk.

The only other deal and interesting one at that, was the €100m from Italy’s Mediocredito Trentino’s (rated Ba1) €100m, 3-year senior preferred costing 2.375%.

True to recent form/trends, equities played out in a narrow range but in the black this time, with little really to chew on in terms of news flow. It was real holiday trading in the markets. In rates, there was better bid leaving the 10-year Gilt to yield 0.72% (-1.5bp), Bund yields are heading lower again and the 10-year is now at -0.34% (-2bp) with the equivalent Treasury offering 2.03% (-2bp).

Synthetic credit continued also to play to the tune of the equity markets, moving up and down in line with stocks. For Monday, iTraxx Main moved lower by 2.1bp to 48.1bp while X-Over was 3.1bp down at 249.1bp.

In the cash market, we have been trading water for over a week already and all was unchanged, although in IG, we reached another record low in the iBoxx index yield level, now at 0.60% (-2bp). There was little happening in the AT1 market (unchanged) while the high yield market was also unchanged (iBoxx index at B+419bp).

We will be back with a final comment for the summer just after month-end. 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.