16th May 2016

As clear as mud

MARKET CLOSE:
FTSE 100
6,139, +34
DAX
9,953, +91
S&P 500
2,047, -18
iTraxx Main
77bp, -0.5bp
iTraxx X-Over Index
324bp, -2bp
10 Yr Bund
0.12%, -3bp
iBoxx Corp IG
B+147bp, +1bp 
iBoxx Corp HY Index
B+507bp, +1bp
10 Yr US T-Bond
1.70%, -5bp

Snatching defeat from the jaws of victory…

It’s suddenly become difficult to predict how this week might play out. The news flow as we closed out last week on the US consumer was good (they’re spending) as shown by April’s retail sales, which topped expectations. But fears on corporate earnings – or rather the quality of them – put a dampener on stocks. The S&P closed nigh on 1% lower in the final session and it will leave the upbeat closes in Europe as having been in vain somewhat. We’re set to open in the red.

There’s a niggle somewhere, a growing disbelief that the US is anywhere close to pulling out of its low trajectory growth malaise. There was a big flattening in the yield curve with the 2s/10s at 95bp. The Treasury market can’t be anticipating a rate hike – far from it, as the 10-year closed 5bp lower at 1.70%.

christine-lagarde

Lagarde: Brexit doom

Eurozone growth for the first quarter just missed expectations, UK construction plummeted in March and a raft of countries reported disappointing Q1 GDP numbers (all the way from Hungary, Poland and Greece to Hong Kong). The IMF threw its hat into the Brexit debate, warning on some kind of financial Armageddon should the Brits decide to leave. Quelle surprise. Just about every political leader and official multilateral organisation (the “establishment”) has now aired a view on the UK referendum – surely they can’t all be wrong.

With all that behind us – and some of it ahead of us, we’re actually looking into this week with some angst. Throw in that over the weekend we had data from China which showed that fixed-asset investment (+10.5%) and retail sales (+6.0%) grew at a slower pace than expected in April, then the slew of poor news continues. The bright side is that the new issue market ought to whittle away at new issues although we dare not expect anywhere close to the €20bn non-financial IG issuance which greeted us last week.

Any equity volatility might impact sentiment, but unless we have big moves in stocks to the downside, we could expect to safely and quite easily absorb up to €10bn or so of new debt (IG non-financials) with little altercation. There is also the Whitsun break to contend with, so we will be off to a very quiet start.

Corporate bond buying programme

The ECB published its Q&A on the purchase programme, and it’s pretty much how we all expected it to be. There was nothing really new in it and just about every borrower wishing to print in euros will effectively benefit, either directly or indirectly.

The takeaways were:

  • They will not purchase debt of a credit institution (i.e., where the parent company is a bank). They can buy the debt of subsidiary banks of companies (VW Bank, BMW Bank, for example)
    The ECB Q&A held few surprises

    The ECB Q&A held few surprises

  • Issuers must be incorporated in the euro area (the location of the ultimate parent is not taken not consideration)
  • No asset management company debt will be included
  • The ECB will buy paper with a minimum remaining maturity of 6 months and maximum of 31 years
  • There is no minimum issuance volume (so they will buy “non-benchmark debt” as we know it)
  • They will be able to buy negative yielding debt (as long as the yield is above that of the ECB’s own deposit facility)
  • 70% is the maximum of any issue they will buy. To ensure portfolio diversification, there will be additional limits per issuer group (that is, to try and limit sector risk)
  • They will buy in secondary and primary; and use the highest rating if the borrower has split ratings (Moody’s, S&P and Fitch have a job for life)
  • Maturing proceeds will be reinvested for as long as necessary

The rest of the Q&A said all the “right things” about credit risk (carefully monitored), how much they might purchase (“no comment”), loss sharing, and most importantly, (secondary) market liquidity. That is, they will be “mindful”! We wonder who makes the decision that a bond is illiquid or not, and how they assess that an issue is illiquid? Defining liquidity in the secondary market is an art, not a science. For example, a tightly held, very rich bond can suddenly become extremely liquid!

Secondary spreads weaker, blame the supply

€20bn of IG non-financial issuance in any week would have an impact on secondaries and they did in the week just gone by. IG spreads widened by 5bp to B+147bp for the Markit iBoxx index with the yield backing up 3bp 1.31% and off the 12-month lows. We’re still thinking in terms of the previous lows on this index being a target for this year (B+94bp, yield 1.02%), but it is now going to depend on the colour and the amount of the ECB’s money as to whether/when we get there. The iTraxx indices closed slightly better offered (lower) at 77bp and 324bp, respectively.

In HY, we had a slightly better performance, with index spreads just 10bp wider at B+507bp, while the yield for the index rose 8bp to 4.79%. We had some HY supply, but nothing in terms of significant enough volumes impacting spreads, leaving the weakness to be more driven by the volatility in stocks. Another 100bp of tightening in HY cash is not impossible, again likely dependent on the extent of the crowding-out impact of ECB buying in IG corporate bond markets.

Away from that, we’re close to testing the recent lows on the Bund yield of 0.07% (back at 0.12%), and with fears around US economic health increasing (see that 2s/10s spread) it will possibly heap some further downward pressure on eurozone yields this week. Equities will likely start off in defensive fashion following that weak close in the US and not helped by the poorer data from China over the weekend. We would think that secondary spreads will find it difficult to rally on that, but that any weakness will be limited and the asset class will outperform stocks. Supply for Monday should be light – if we get anything at all – leaving us to kick-off proper on Tuesday.

Have a good start to the week.

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.