15th June 2016

Nothing’s gonna stop us now

MARKET CLOSE:
FTSE 100
5,924, -121
DAX
9,519, -138
S&P 500
2,075, -4
iTraxx Main
88bp, +6bp
iTraxx X-Over Index
375bp, +26bp
10 Yr Bund
-0.01%, -3bp
iBoxx Corp IG
B+148bp, +3bp 
iBoxx Corp HY Index
B+508bp, +18bp
10 Yr US T-Bond
1.60%, -1bp

An unholy concoction riles the markets…

There’s a lot in the pot being stirred at the moment, the ingredients neatly brewing up a massive storm such that even the ECB’s huge interference in the corporate bond market is failing to stem weakness there. But the story of the session had to be around the collapse of the German Bund yield, as the 10-year crashed through 0% to -0.03% at its intraday low. We’re paying them for the privilege of storing our cash. With it, the 10-year Gilt yield dropped a stunning 8bp to 1.12% and a new record intraday low level. The 15-year Bund is now yielding 17bp and we think is the next to go negative as the Eurozone economy and bond markets Japanify. Or go Swiss, or a combination of both. The outperformance was at the longer end, with the 30-year Bund up 2.5 points and the 30-year Gilt up 1.4 points. That is, government bond curves were flattening, since the front end is effectively anchored.

Europe-Great_BritainIt is clear to us that the current flight to quality and move away from risk assets (equities, oil) has more to do with the upcoming Brexit situation than anything else. The macro weakness is old news and has been like an on/off switch for years. The Brexit referendum though throws something new into the mixture and just as nature abhors a vacuum, the markets hate uncertainty. The easiest trade is to chase safe havens – hence the weakness in stocks. There is some contagion into credit, but it is moderate in IG as the ECB is lurking. It is more pronounced in HY, as there is no obvious back-stop bid.

Blaming it all on Blighty

Lower Gilt yields are the direct result of the Leave camp leading in the UK referendum polls. The natural reaction is fear of the unknown leading to a subsequent dash for safety. Few are thinking of the hope it might mean and bring for the future. However we look at it, we would have thought bond yields would have got to these levels anyway – albeit in a more orderly fashion – over time, given the parlous state of the global economy. Anyway, the contagion has reached far and wide. The US bond market is rallying; Asian risk assets are reeling, feeling hot under the collar; European equities have taken a pummelling; and sterling is weakening. The DAX is now 12% lower YTD – it was 18.5% lower at its worst point in January but just 4.5% down a week or so ago. The French CAC index is off around 10% so far this year. By the way, it should not be lost on us that the FTSE is down just 4% YTD. UST 2s/10s is back at a 9-year low of 88bp as the curve there flattens too.

Some business still gets done

sysco

The IG Market saw a €500m deal from Sysco

Primary was open for business and we had a couple of IG borrowers in the market. FCA Capital raised €500m as did US corporate Sysco, adding €1bn in total to the monthly tally and taking IG issuance to €9.1bn for June so far. In HY, PVH Corp issued €350m (to be priced). There was nothing in unsecured financials. Overall, June has so far disappointed on the supply front and we would think only one borrower’s deal has been worth getting excited about – the multi-tranche €3bn offering from Air Liquide last week. Now, the FOMC looms large and then we have the big UK referendum vote, so we can expect little business to get done in primary this side of the 23rd June.

Dramatic day ends with bit of a thud

Equities lost more ground to close around their session lows. The DAX lost another 1.43%, the FTSE saw a decline of 2% and most other European indices were in the red by 2% or more. Oil (Brent) gave up on $50 and was left trading with a $49 per barrel handle. As for government bonds, the 10-year finally ended off its intraday low yield at -0.01% (-3bp) as did the 10-year Gilt at 1.14% (-7bp). It was a safe-haven bid that was the driver given that the periphery underperformed with Italian and Spanish yields 5-6bp higher. Italian BTP 10-year yields are back up at 1.50% for example. These government bonds are clearly not – nor seen as – risk free assets! Greece 10-year debt yields were back up through 8%, some 36bp higher.

However, the broad rally in Eurozone government bonds has boosted returns with the index now returning 3.5% YTD. However – and admittedly a longer duration product/index, but Gilts are top of the performance pile, returning 8% YTD.

In the credit markets, as mentioned the supply offered very little and certainly nothing to excite. So the focus was on secondary and we endured a light session, but there was a clear defensive bias to it. Spreads for IG corporates as measured by the Markit iBoxx index were 3bp wider at 148bp, although the index yield was a basis point lower at 1.21% as the underlying was bid up. Once again, even here, the ECB’s purchases are failing to halt the discontent the markets have with all risk assets/corporate bond valuations. Sterling corporate bond spreads have also started to widen, 4bp in yesterday’s session but, total returns have climbed to 6.5% YTD.

In HY, the market was under significant pressure, with the index widening 18bp to B+508bp in the session. That was to be expected given the close correlation of the HY market and its valuations with stocks – but also from the lack of direct ECB support (from the purchase programme). Traders naturally run scared. The wrath of the market towards credits repricing was also seen in the iTraxx indices. Main jumped a massive 6bp to 88bp and X-Over 26bp to 375bp as the cost of protection rose sharply.

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.