3rd May 2016

Chapter 5… May

MARKET CLOSE:
FTSE 100
6,242, -81
DAX
10,123, +84
S&P 500
2,081, +16
iTraxx Main
73bp, +2bp
iTraxx X-Over Index
312bp, +10bp
10 Yr Bund
0.27%, +1.5bp
iBoxx Corp IG
B+139.3bp, unch 
iBoxx Corp HY Index
B+577bp, -4.5bp
10 Yr US T-Bond
1.87%, +3bp

Mayday, mayday…

We didn’t quite plunge into the depths and need to send out a distress call, but it was a yucky end to April. In fact, the last week of the month was ruinous for the performance of equities, although most bourses were higher on the month as we closed out. Oil prices have continued their ascent, though. Government bonds have fallen back, serving to highlight the precarious nature of investing in, say, Bunds when yields are at such low levels and leaving paper-thin breakevens. Corporate bonds closed the month a little tighter in spread terms, but the final week saw some moderate weakness and a flat performance on the back of it. Still, the demand is there and while we had plenty of takers for yet another zero-coupon/close to par-issued/almost negative-yielding deal, we dare say more are coming. We now believe it won’t be long before a new issue launches with a negative yield at re-offer.

It’s almost madness that investors are prepared to tolerate such low coupon/yield levels, but their cash holdings are also costing them – and more. Depending on the depositary used, fund managers holding cash can be charged anywhere between 40bp and 100bp for their deposits. So buying a corporate bond yielding more – but also negative – “makes sense” in this case, and corporate bonds become the lesser of two evils. That’s all fine and well while yields go lower and spreads tighter, with capital gains offsetting some pain, but it also means we’re hoping there is no catalyst any time soon for an unwind in corporate bond risk positions.

Hopeful for corporate risk through May

It’s not always the brightest of months for risk assets, but we believe credit markets in Europe will continue to perform relatively well given the ECB’s interest.The Markit iBoxx IG corporate bond index closed April at B+139.3bp and some 14bp lower on the month, returning 0.35%. Those returns were better just 3 weeks into April, and close on 1%, but the sell-off in the Bund erased the gains. Still, for the year to date, IG bonds are returning 2.6%, and that 4%-like area is possible as long as the underlying doesn’t sell off (too much). Also, IG non-financials have returned an impressive 3.3% in the first four months. In spread terms, the sterling market has had a very good month, with the IG index left at G+177bp (-19bp), while yields have fallen just 5bp to 3.62% as gilts have sold off a little. Returns for this longer duration corporate bond market are up at 3.1% for 2016 so far.

High yield though has had a remarkable recovery. Under water and seemingly much unloved through January and February, year-to-date returns are up at a stunning 3.5%, with a remarkable +2% performance in April alone. The index spread has dropped to B+477bp, or 50bp since the beginning of the year. Even the new issue market for HY corporates is reopening, and we have now had two consecutive months of €4bn+ supply after almost nothing in those opening two months.
We’re in uncharted territory as far as zero-coupon, low or negative-yielding bonds at new issue are concerned, but the demand for corporate debt is undimmed and unless we get major volatility elsewhere, returns – total and benchmark – are going higher.

Using the iBoxx index as a guide, we still believe that its IG component head will towards that record low we saw a year ago (another 45bp tighter at least from here) and will just need the catalyst that comes from the ECB starting to lift paper in a few weeks time.We’d probably need some major event to derail the trend – akin to problems with Greece’s bailout flaring up again, or say another significant drop in the oil price.

High yield corporate bond returns on the up

2016 YTD returns

Oil, Equities and Govies

That trio is not our forte, but it’s worth a comment. While credit has been a beacon of stability and predictability, there has been much concern about the volatility around that trio. Oil saw $26 per barrel (Brent) in January and was seemingly on the way to a sub-$20 level before perking up, and $50 per barrel is now within reach, There are warning signs that this level or higher is unsustainable and we’re heading for lower prices again as the global glut builds, but really, few have a good grip on where the price is going. The shale gas fraternity will be watching as idle rigs will come back on line should the price go higher and look sustainable as it does.

As for government bonds, the ECB’s buying programme has long been known about and the increased asset purchase programme hasn’t had much of an impact on longer-dated yields given that the 10-year Bund yield had dropped to 7bp before visiting 0.31%. It’s now back at 0.27%. There has been much more around the latest economic data amid signs that the eurozone could be stabilising, albeit at a low level, but the region is caught in a deflationary trap. Unemployment is falling (10.2% now), consumer spending is mixed, business investment poor and growth still diverging across the region. We remain of the view that more economic misery is coming – or that at least we stay where we are – and that Bund yield (amongst others) will be heading lower again. Eurozone government bonds have returned 1.9% YTD.

japan-stock-market-down

Slip sliding away: Japanese stocks

Stocks are staying put to macro news flow – less to earnings we think, but most of all to US rate risk. With that, there has been a bit of a sell-off into the end of April, and once again the DAX has bore the brunt of it. Last Friday’s close, almost some 300 points lower, keeps that index firmly in the red YTD, by 6.5%. In fact, there has not been a single session in 2016 where the DAX index has actually been in the black – not even intra-day. The €Stoxx 50 is down 8% and the FTSE flat, both YTD. Even the S&P has given back some gains, but it is 5 points to the better from start to finish in April, though up only 1.1% for the year to date. For Japanese stocks it’s worse, they’re down by over 15% YTD!

Primary important or its dull

Without decent levels of supply, the corporate bond market becomes fairly dull. Event risk of Volkswagen ilk generates some interest, but the daily flow and volume is at such low levels that it’s primary or nothing. The IG non-financial run rate has passed the €100bn barrier YTD reaching €104bn, while the senior financials level is up at €76bn and about average for this market since the crisis began. While IG market volumes look perkier after a couple of heavier months following a poor Jan/Feb, the same can’t be said of the HY market. Admittedly, €4bn+ has been printed for each of March and April, but it is a very low level that sees an aggregate issuance of €10bn YTD. With spreads tightening and returns rising, we can only hope for returning confidence to help with higher levels of supply in the high yield market. Even so, it is difficult to think that the full year could see upwards of €30bn printed in total.

And that’s about it. The week brings us more on the earnings front and we close out on Friday with non-farms. European markets were open yesterday and moved higher with the DAX clawing back almost 1%. PMIs were mixed and overall highlight a continued very low level of manufacturing growth across the eurozone. In the US, there was more evidence of a growth slowdown in manufacturing in the latest ISM numbers although the prices paid component was sharply higher. Oil prices fell with Brent down at $46 per barrel (-3%).

Have a good Tuesday.

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.