Reloaded & ready to go again

Roll up those sleeves…

We are having that pull back in spread markets. That little reminder that markets don’t go in any direction for too long before they correct. We had been in bullish mode for well over two months and the weakness last week was probably a timely reminder of the over-exuberance in the market right now. Nevertheless, Tuesday’s session was a good one for the corporate bond market but with just about all the focus on primary.

Borrowers flooded us with deals in euros and sterling, leaving secondary to follow (a little tighter) amid no real interest by investors to get involved. Deals came from the likes of EdP, PostNL, Toyota and Iberdrola in euros but the biggie was British Telecom’s 3-tranche foray into the euro and long-dated sterling markets. Offerings are somewhat a rarity from this borrower.

The news flow was good, as German GDP for Q3 topped estimates coming in at 0.8%, the same was observed in Italy with Q0Q GDP up 0.5% while industrial production growth in the Eurozone slowed to 3.3% in the year to September (versus the year to August) but did beat expectations. In the US, producer prices rose much more than expected, and might have put a dampener on risk assets with some thinking that a US rate rise might materialise before year-end.

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They’re back!

Some more of the same…

The big picture for credit has investors concerned about the level of the market and the timing of ‘the’ correction. That big event is unlikely going to occur just yet. Most will safely assume that 2018 is the timing for that and will use the rest of this year to protect their stellar performance. That means we will just grind tighter.

We have had periods this year – like last week – where we have some decent weakness in the markets, but we have usually recovered quite swiftly. That can happen again, although given the more disjointed period we have ahead as we take in the US Thanksgiving break (23/24 November) and then wind down for the Yuletide period and year-end, then the tights we saw a couple of weeks ago might the best we can hope to equal. There is nothing wrong with that, because it means we will have had a great year.

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If it was just that easy!

Defeat from the jaws of victory…

We came into last week on such high expectations that spreads would continue to squeeze tighter, but we were completely wrong-footed. Not because there was any measurable or obvious better selling cares, or that we had a credit market related event that scuppered those expectations.

Nor was it that we had so much issuance that a back-up was always likely into it. We were wider because the equity markets were a little more volatile and lower in most cases through the week. Again, there was no obvious reason why that was so (maybe US tax reform delays?), except that valuations for equities are a little lofty at the moment and we were lacking a catalyst/trigger to help them push on.

Whatever, high grade credit – as measure by the Markit iBoxx index – saw cash 2.3bp wider, just when we were a basis point away from reaching a record tight for this index. High yield spreads rose from their record lows to close the week 21bp wider (most of it coming on Friday), amid just a few deals in the week in primary. And the stand-out sector this year, the CoCo market, also saw some weakness with spreads around 31bp wider on an index that had seen record lows as well.

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Soggy end to the week

Playing the game…

There was a cautious tone to the markets again and after several sessions with that being the case, we must be thinking in terms of a reluctance by investors to chase the markets deeper into record territory so close to year-end. That certainly seems to be the case for European equities, while rate markets are stuck in a fairly tight range of late, cognisant of the potential for event risk given that Trump is on his travels and the Saudi domestic/Iran situation still needs to play out.

Credit is focused on the new issue market – which is delivering enough for investors to be happy with, while spreads are no longer ratcheting (or rather grinding) relentlessly tighter. Of course, when high yield markets are no longer ‘high yielding’ (in historical terms anyway) we’re obviously extremely cautious about the need to chase the market.

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Whacking out the deals

Primary bursts into life…

There was no midweek lull in the corporate bond market. The credit market was not for taking a break following a couple of days this week of decent primary activity. We had another bunch of deals keeping investors occupied and feeling a little relieved, as cash balances which need to get absorbed before year-end are doing just that. We might just be full-steam ahead into the Thanksgiving break and €2bn or (much) more of non-financial issuance per day at the moment is getting done.

Some will be advised and/or tempted to wait a while, because conditions will remain just as accommodating in Q1 as they are now. It’s just that there will be a gamut of borrowers to contend with, then all looking to get their funding away early once the new year kicks off – so get it in early. Anyway, we weren’t devoid of issuance as the likes of BASF, Union Fenosa and UPS in non-financials amongst others pitted their wares.

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Tensions rise in Middle East

…but they will soon pass

The markets have had a bullish disposition about them for the best part of three months. Record closes again in the US overnight and a solid rally in Asian stocks, with commodities heading higher helped by that shake-out on the Saudi domestic front along with rising tensions with Iran (oil at 2-year highs) gave us every reason to trade through a rather mixed and eventually weaker session.

A very positive European open was soon faded, with equity indices closing out up to 0.7% lower. It is certainly a case of ‘baby steps’ as far as European equities are concerned, as they make any gains with a more cautious stance versus their global peer groups. And that’s fine, it’s perfectly natural to trade this way and we are hoping that there are no major event-risk driven lurches lower that would ultimately impact the corporate bond markets.

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Record high/low beta credit compression

Warning signs but more to go?…

Such has been the demand for higher yielding credit risk that the outperformance of this part of the credit market has seen a quite remarkable compression between high yield and investment grade valuations. For instance, the difference between high yield and IG spreads is now at a record tight (157bp) with 15bp of that coming in the last month and 110bp of it this year, as measured by the Markit iBoxx cash index (see chart).

The bigger the risk associated with a structure, the greater the performance of it and therefore the larger the compression.

The AT1/CoCo market has been on fire. Of course, when we get to these levels, some are thinking/expecting a pullback. Fortunately, the excess liquidity in the system will likely prevent that from happening, given that the accommodative policy stance is going to unwind only slowly.

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It’s your friend!

Strap on some risk…

US hiring might have come in lower than expectations (261k actual vs 340k expected), but it was a big ‘corrective’ number and the picture remains promising as the economic outlook brightens. We have a firming recovery, the US unemployment rate dropped to its lowest rate for over 17 years to 4.1% – while wage growth also declined (to 2.4% year on year from 2.8% the previous month).

That’s all good news for investors! We think that there ought to be a real zest about the markets because the trajectory of an economy blowing not too hot or too cold is just about perfect at this stage of the economic recovery, along with a drawn-out rate normalisation process.

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Markets react to being dumbed down

By adding a little bit more…

The best we could say about the market right now is that it embraces a reflective mood – thinking about the FOMC just gone, the earnings season, the next catalyst to push us higher, the next Fed chairman, Trump’s tax reforms and more immediately, today’s non-farm payrolls.

At least we had some better activity across the primary market after what seems like an age with several session of little or no supply – or nothing to inspire anyway. Eurozone equities gave a little of the previous day’s gains back, rate markets were still treading water and credit was unchanged to better bid for choice, where the squeeze in spreads is taking us deeper into record territory. That systemic event risk – likely the only thing that can derail the markets – delivering a knockout blow to investors who are just as long as they can be, is seemingly as far away as ever.

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As good as it gets?

No, there’s life in the old dog yet…

There was little distraction from the Fed’s rate decision in a session where European markets rallied hard. Equities gained over 1% in some cases, iTraxx Main Series 28 dropped through 50bp, cash credit squeezed some more and rate markets were fairly stable. That’s about as good a start to the month as we could have expected. With oil prices on the up and the energy sector getting a huge boost from it, it has not been forgotten on us that it means the shale producers will be pumping away and default rates in that industry will be declining. Why does that matter? Confidence. Confidence in US high yield and that will filter through to sustaining the bid here for what has become a very rich asset class (in historical terms).

After all, HY spreads are at record tights, index yields at record lows and the cost of funding for HY rated corporates has never been so cheap. There’s no stopping the demand for higher yielding assets while market rates remain anchored and seemingly refuse to burst higher. Equities might be up 15% or more this year (DAX, S&P500 and Dow, for example), but the high yield market has exceeded 6%, CoCos 17% and even IG returns are approaching 3%. That’s great returns for fixed income.

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