8th March 2016

ECB’s Power Rangers to the rescue

MARKET CLOSE:
FTSE 100
6,182, -18
DAX
9,779, -46
S&P 500
2,002, +2
iTraxx Main
90bp, -2.5bp
iTraxx X-Over Index
369.5bp, -4.5bp
10 Yr Bund
0.22%, -1bp
iBoxx Corp IG
B+174.8bp, unch 
iBoxx Corp HY Index
B+595bp, -4bp
10 Yr US T-Bond
1.90%, +3bp

Waiting for a defining moment… This week could well define not just the first term but the first half of 2016 in with respect to performance. It has the potential to deliver a binary outcome. If the ECB throws the kitchen sink at it – that means a 20bp deposit cut and €15-20bn on the asset purchase programme – then the markets will be all cock-a-hoop and rally hard into it, especially after the reception we gave to the potential for a sustainable recovery in the US at the back end of last week. On the other hand, if it moves with the baby steps for which it has form – driven by consensus politics and now bowing to market expectations – we will be left with the usual air of uncertainty. That will probably mean an initial rally of sorts, which we will fade, and then reviewing the situation as and when the incoming data dictates. No squeezy bum time, just a bit of pragmatism. And it seems that is what we saw in yesterday’s session. Oil prices per barrel rose, metals prices were on the up and Chinese reserves fell – though less than expected. Yet Italian producer prices declined again in January, as did German factory orders. After a good week just passed, we were off to a weaker one as equities came off by around 1% or more and decided to take a cautious positioning. Credit followed, with the synthetic indices higher (credit insurance costs higher) and cash under some widening bias. There was just one deal on the new issuance front, although we read little into that given that Mondays are usually subdued at the best of times.

Time to step away from the herd… Such is the difficulty in having any kind of conviction that we now see oil price positioning has become bullish. Brent has thus pushed upwards of $40 per barrel and is almost 5% higher YTD (versus -35% in January). Why? The US shale rig count has dropped by 50% since its peak, and we can’t of think of much else to justify such an aggressive turnaround save for the view that we had dropped too far in the first place. It does seem like fast money is dictating the direction of commodity prices. This matters, because it can and has impacted sentiment such that other asset classes get caught up in the price action and move undeservedly, unable to decorrelate. That is exactly what we have observed since the beginning of 2014 in the HY asset class in corporate credit. That shale boom and subsequent bust beat up the HY market as a whole in the US (only now recovering off the lows) as the contagion impact got the sector a little hot under the collar. A still fledgling HY market in Europe felt the heat and has sold off aggressively too. Fledgling because we should have stepped back and not sold off into that HY weakness. And that’s even as the default rate has been pinned at under 3% for European HY corporates for the past 6 years, while in the YTD we have seen a paltry €2.5bn in supply (almost €50bn average per year in 2013-2015). Those dynamics alone ought to come to the rescue of HY valuations in Europe, and the wide spreads suggest some low-hanging fruit is ripe for picking. If the opportunity presents itself, why not?

Off the lows, everywhere – but headlines around oil… We closed out the session with everything pretty much off the lows. Bund yields closed off them with the 10-year at 0.22% having resided at 0.20% for much of it, for example. Equities recovered to close less in the red, the DAX for example over 1% lower in the session only to recover to finish 0.46% down. That pattern was repeated in other equity bourses. Oil was the exception as Brent had a super day ending close on $41 per barrel. Incredibly, corporate bond spreads as measured by the Markit iBoxx corporate bond index for IG closed completely unchanged at B+174.8! The index yield was a tad lower as the underlying was better bid. Within that though, the higher beta sectors (hybrids) saw some moderate weakness as did the CoCo sector. High yield spreads closed a touch better for choice as the sectors recovery continued with spreads at B+595bp and the index yield at 5.65% was 5bp lower (it was 6.43% a month ago). iTraxx Main outperformed with the index down at 90bp and X-Over dropped a touch to a shade under 370bp. Triple-B rated International Flavours and Fragrances (!) was the only deal in the market, adding €500m in 8 year funding for the US borrower.

Back tomorrow, have a good day.

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.