- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
|FTSE 100 ,||DAX ,||S&P 500 ,|
Central banks front and centre…
It would appear that we are just tying up the loose ends now. Even the central banks are going to be doing that as the “Big 3” all have their respective meetings. The markets are in no mood to get ahead of themselves.
It’s been a super year for everyone and few will argue against that, given the potential for turmoil from the many banana skin-like events. Trump’s surprise election win and inauguration as US President, and the turmoil and scandal which has since followed and continues. The ongoing shenanigans around the Brexit issue and the lack of a German government. The much more very serious geopolitical risks especially taking in the North Korea/US spat. Generally, we would say that the excess financial market liquidity has been our saviour.
That liquidity has needed a home. And it has gone where the low-hanging fruit has been. As a result, all markets have exceeded the performance of even the most bullish of expectations. After all, how often does the Dow rise by 24% in a given year?
The current craze is Bitcoin – or rather cryptocurrencies. We might not fully understand them, old-school bankers are bashing them but they’re gaining a massive head of steam. It could be a bubble. But it might be the new way forward. Dare one miss out? But they have deflected the attention into the end of this year away from the heady levels reached in other asset classes. In credit, for example, it is about how tight credit spreads are, how rich valuations are on any measure and the risk to the asset class from any kind of unwind – orderly or disorderly – in 2018.
Disorderly looks unlikely in our view as that needs a crisis in the financial system. Having got this far in the financial crisis, we don’t think the central banks would shy away from an effusive policy accommodation should it be necessary. They’ve already dumbed ‘it’ down to zero once, after all.
Given the vagaries of the economic cycle, even the impact of it in terms of releveraging of balance sheets as the M&A party gets into full-swing might not be something we witness next year, despite having had a fair smattering of deals in 2017. But the big industrial transformational, credit quality destroying, bondholder unfriendly deals have been a scarcity – and that includes the period before even the financial crisis started.
As for an orderly unwind in credit, that is quite possible. A process could take in a slowdown in inflows, less demand for new deals with oversubscription levels falling, leading to less tightening in spreads versus the initial price talk or a greater premium versus secondary curves than we see at the moment. Once we get that, secondary will adapt and reprice wider. Set against that would be fundamentals and supporting credit would be better macro leading to a continued improvement in credit metrics. So a moderate weakening in credit spreads could be possible – likely even – in 2018.
Mixed news flow day
News in the day saw the Democrats in the US win the Alabama Senate seat, against all expectations (deeply conservative area) and a victory which is seen as a blow to Trump and the Republicans, leaving the Republican party with a slim single vote majority in the House. Everything just got harder for Trump in terms of him getting his controversial reforms through the legislature.
In the UK, the latest employment report was seen as weak as the number of people employed declined again (by 56,000) in the period measured between August and October, versus the 3-month prior period. Annual wage growth rose to 2.5% in the same period, but still lags that 3.1% CPI reading. There’s nothing in the report that suggests the BoE will alter policy and we expect it will remain on hold for most – it not all – of 2018.
On the plus side, Eurozone industrial production rose 3.7% in the year to October as did employment in the area in Q3 versus Q2, suggesting that the Eurozone’s economy continues to tick along nicely.
Markets fizzle out
The new issue market piped up with a couple of deals. Neither were necessarily opportunistic as we might have expected. Iceland returned after a 3 year absence and Unicredit opted for an AT1 transaction. The A3/A rated sovereign took €500m off a €4bn+ book at midswaps+35bp (-20bp versus the opening guidance). The contingent convertible PNC 6/2025 structure from Unicredit attracted over €2bn in orders for the €1bn deal priced to yield 5.375% (which was -0.25% versus IPT).
Rate markets saw government bonds better offered for most of the early session, but they made an abrupt turn after core US CPI dropped to 1.7% in the twelve months to November from 1.8% previously. Benchmark bond yields ended with Gilts at 1.22%, Bunds at 0.32% – and both unchanged, while US Treasuries fell back to 2.38% on the news of that subdued core inflation. Treasuries later rallied and the yield fell to 2.35% on the 10-year.
Equity markets were doing very little – just as we might have expected given the focus on the central bank meetings. In Europe they ended a small down while prior to the FOMC’s call, US equities were up slightly.
In credit, the synthetic space saw protection better offered for choice, leaving Main higher at 47.8bp (+0.4bp) and X-over protection up at 233.9bp (+0.9bp). As for cash, the Market iBoxx IG index closed unchanged at 99.3bp and the high yield index a little wider at B+300.7bp (+1.5bp) and all in a very limited session.
And last, but not least, the FOMC delivered what we all expected with that 25bp rate hike and the potential for three hikes in 2018.
Have a good day.
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