22nd March 2020

🗡️ Catching a falling knife

MARKET CLOSE:
iTraxx Main

118bp, unchanged

iTraxx X-Over

685bp, +8bp

🇩🇪 10 Yr Bund

-0.34%, -10bp

iBoxx Corp IG

B+249bp, +2bp

iBoxx Corp HY

B+882bp, unchanged

🇺🇸 10 Yr US T-Bond

0.88%, -24bp

🇬🇧 FTSE 100 6220.14, (+0.87%) 🇩🇪 DAX 12021.28, (+3.75%) 🇺🇸 S&P 500 3080.82, (+0.49%)

UK goes for broke, others to follow…

In a last throw of the dice, Britain has closed for business. Encouragingly and correctly, the fiscal response has been immense, unprecedented in its size and nature and broken many a financial taboo. A volcanic-like explosion of liquidity and support all being necessary as the country (and world) heads into hibernation mode.

The economic impact of the pandemic will see the negative slope on the way down. It looks like we are going to see atrocious double-digit numbers for GDP in Q1 and Q2 (deep recession), while the upward slope will go a long way to correct it. Once we see the evidence that the latter can happen (development of a successful vaccine, for example) we will see the markets fly, and it could be a huge rally. The numerous fiscal largesses will make sure of that.

It is going to be some correction. After all, just look at where we are year to date: FTSE -31%, Dax -33%, S&P -29%, IG credit -6.6%, HY -18.8% and AT1 -23.3%.

That’s something to look forward to. For now, stay defensive – although the ability to trade at reasonable prices has been severely curtailed. Given the huge levels of uncertainty ahead, there is little reason to get involved. Why would you?

The next days/week will see more of the same difficult, national shut-downs. An increasing number of regions in the US are locking down now and soon the whole country will be. Borders are closed almost everywhere. ‘It’ is going to get worse for us all.

And so the economic numbers – earnings, GDP growth, unemployment and so on are going to be awful for the whole of the first half of 2020, and if we don’t get grip on Covid-19 pandemic, likely beyond.

We don’t know where the market bottom might be. We’ll just brace for more weakness. The warning signs for anyone wanting to get involved are clear. We would think that it best not to get involved, yet.

Primary credit registers huge interest

Amid all the uncertainty, there’s no sitting back and waiting for some. Self-isolating was out of the window where Unilever and Engie were concerned, as these corporate borrowers ploughed into the market, launching dual and triple-tranche deals in last week’s final session. The solid well-known entities might have played into Friday’s improved tone on the back of equity and rate markets rallies. But they have paid up for doing so.

The former issued €2bn split equally in a dual-tranche 5-year (at midswaps+140bp) and 10-year (at midswaps+170bp) where the initial price talk for the deals was +60/70bp versus the screen prices. Final pricing was 25bp inside the initial guidance with interest for the deals up at impressive €11bn. Engie issued €2.25bn in a three-tranche effort taking in 5-year (midswaps+160bp), 8-year (midswaps+180bp) and a 12-year green bond (midswaps+210bp) maturities. Total books exceeded €10bn and final pricing was 20-25bp inside the initial guidance across the tranches.

The long view is that when we emerge out the other side, these types of IG rock-solid corporates will see their spreads tighten (the most) first. At that stage, we will be trying to get a handle as to how lower-rated/high yield entities (and non-utility like ones) might fair as we enter the macro recovery phase. It’s going to be a long wait.

But better than sitting on cash. Better, also, than being in rates markets. Best to avoid the volatility in equities and park it up in good quality credit. Add in a fear of missing out on a bargain  – all combined to see investors taking down the Engie and Unilever issues and effectively averaging back into the market. As shown, there has been no shortage of demand for the new deals on offer, with demand at impressive levels which belied the crisis narrative.

Another false dawn closes us out

Elsewhere, the earlier buoyant opening across the markets was faded on Friday. The worsening news flow made sure of that. The FTSE closed just 0.46% higher after rising by over 5% at one stage, the Dax fared better though as it rose by 3.7% but was higher earlier in the day.

The US markets were in the red as lockdowns across the country increased and the losses worsened as the UK Incs shutdown news filtered through. Equities eventually closed over 4% lower.

In rates, that QE effort to help fund the necessary fiscal splurge saw rates better bid. The yield on the benchmark 10-year Gilt closed 15bp lower at 0.55%, the Treasury at 0.88% (-24bp) and we were 10bp lower at -0.34% for the 10-year Bund yield.

In credit, the IG index edged 2bp wider to B+249bp and the HY market did the same, the iBoxx index left at B+882bp. The better performance in European equities and potential for huge support for the region’s banking sector saw a tentative tightening in the AT1 market leaving the index 100bp tighter – but still at B+1,400bp!

The synthetic credit indices closed pretty much unchanged with Main left at 118bp and X-Over at 685bp (+8bp).

As for this week, there is plenty of economic data due with services, manufacturing and inflation updates for March across all markets catching the eye a little, because the focus is elsewhere.

Reports over the weekend suggest that Germany was also readying a massive fiscal response, perhaps in excess of the UK’s one, where a TARP-like programme will be used to take equity stakes in stricken companies. In the US, there is an injection in excess of $1 trillion being discussed.

All these efforts will provide some considerable support to the markets, if true. Alas, with so much debt coming online, the arguments over ECB breaching QE purchase-related sovereign debt limits should fade away.

Good luck.

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.