17th May 2016

Champing at the bit

MARKET CLOSE:
FTSE 100
6,151, +13
DAX
9,953, closed
S&P 500
2,066, +20
iTraxx Main
78bp, +0.5bp
iTraxx X-Over Index
328bp, +4bp
10 Yr Bund
0.14%, +2bp
iBoxx Corp IG
B+147.7bp, unch 
iBoxx Corp HY Index
B+507bp, unch
10 Yr US T-Bond
1.75%, +5bp

Plenty to think about…

Oil

Stunning recovery: Oil, that is

Many jurisdictions were closed as a result of the Whit holiday, but we still had much to ponder. Foremost, the UK was grabbing many of the headlines. Not about Brexit, for a change, but the potential for a rate cut sometime later this year. Economic indicators have been a little more stressful of late (construction activity, growth overall, inflation stubbornly low with weak PMIs and so on) and the Gilts market is reacting. Mind, it is has been moving almost in lockstep with the Bund/Treasury markets as any positive economic news continues to flatter to deceive. At 1.35%, the 10-year Gilt is not far off the 1.24% intra-day low; the equivalent Bund at 0.12% (intra-day record low 0.05%). Oil was on the up, with Brent in touching distance of $50 per barrel and on the verge of seeing an incredible 100% recovery off the January low ($26). Now there’s an option-like return if ever we saw one.

Equities were on the back foot in yesterday’s session, understandably so after the weak close in the US at the back-end of last week. For corporate bond markets, there was little going on, although VW’s woes are set to remain prolonged as Norway’s sovereign wealth fund was on the warpath, looking to sue the carmaker following the emissions scandal.

In all, little has really changed on macro over the past several years. The economy continues to blow not too hot and not overly cold. Policy remains accommodative everywhere and there is the non-trivial probability of further easing to come in most jurisdictions. Low rates, low yields, whippy stocks and ‘who knows where oil might eventually go’ look like being the market dynamic we will be facing for a while yet. Positioning for that means money stays within the fixed income markets for the assuredness coupon income brings, preservation of capital and perhaps even some appreciation of that capital should rates/yields go lower.

But don’t worry about the default rate

Much is being said now about rising corporate default rates – in the US. Of course, high yield prices have risen from their January lows, much in line with the recovery in most other asset prices, but the default statistics are lagging indicators and are playing catch-up. We can have a default rate cycle in the US way ahead of that in Europe. We usually do. But we can also have a much higher default rate in the US and it might end up higher than in Europe at the peak. It likely will. Some of the reasons are that monetary policy between the two regions is at a slightly different stage, while the make up of the companies defaulting in the US is steered towards the energy/commodity sectors. Over here it is different.

So we believe, that over the medium term, the ability of the corporate sector to service its obligations will remain undimmed by macro weakness and we will sustain an overall lower default rate over the next 12-months say, than corporates in the US. The rate environment ought not to be the only driver of performance/spreads, but such has been the manipulation of the market because of it, it’s close to being the predominant driver. Also, both markets have recovered, but European HY didn’t gap as much as in the US, nor did we see the velocity of outflows experienced in the US. Ours is a more illiquid market, still fledgling in our view, but still worth a look at despite the macro machinations.

Ready, steady, go

The word is that primary is going to burst out of the starting gates as this shortened week seeks to make up for Monday’s public holiday-lost session. We’ve had an excellent month of it so far and a couple of sessions of no or little issuance has allowed us to absorb the near €27bn of IG non-financial issuance and ready for the next batch of supply. Another €12bn leaves us with it being a record for any May month, while €22bn between now and the end of the month would be an all-time monthly record. All said, the pressure on secondary is very limited given the amount of supply seen over the past couple of weeks (courtesy of the ECB impending grabfest).

We closed out with stocks unchanged for those markets that were open, although they recovered off being up to 0.8% lower. With Brent up at a little over $49 per barrel, it gave a boost to US stocks and that fed through into sentiment for Europe amid low volumes admittedly. US stocks were having a good session of it, with the S&P up almost 1% while Treasuries gave up some of last week’s gains, the 10-year yield up at 1.75% (2s/10s at 96bp, +1bp).

In credit, and as measured by the Markit iBoxx index, sterling returns are having a good year. Already, the index for IG corporates are showing returns up at a stunning 4.3% YTD, while spreads have edged out 6bp. That is a fantastic performance. otherwise, we close out unchanged in IG (perhaps with the slightest of bias towards some weakness) while the HY market ended with spreads essentially unchanged, too. The iTraxx indices ended slightly better bid with Main up at 78bp and X-Over at 328bp.

Back tomorrow.

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.