16th March 2020

🦠Corporate Bond Market March 2020 in Charts

MARKET CLOSE:
iTraxx Main

120bp, +8.5bp

iTraxx X-Over

609bp, +83bp

🇩🇪 10 Yr Bund

-0.47%, +12bp

iBoxx Corp IG

B+205bp, +17bp

iBoxx Corp HY

B+747bp, +87bp

🇺🇸 10 Yr US T-Bond

0.74%, -21bp

🇬🇧 FTSE 100

5510.33, (-5.25%)
🇩🇪 DAX

9632.52, (-3.68%)
🇺🇸 S&P 500

2541.47, (-3.37%)

Don’t stop now…

It’s real. We are in the midst of a global financial systemic crisis borne from a global health Covid-19 virus-related pandemic. The virus does not understand monetary and fiscal easing as it continues its savage path around the world. The easing measures are in place to try to limit the economic downside. They might help, but likely only at the margin.

However, it feels as if – and is quite likely that – we haven’t seen anything yet. Once the whole of the US retrenches (locks down) and we see the same just about everywhere else, there is more downside to come in markets. This financial/health crisis likely doesn’t end by Easter. We are not even in the exponential phase of the diseases spread in many jurisdictions.

V, U or W potential macro recovery shapes aside, we just might need to have another look at the global ‘business model’ of the past 40 years and the culture that went with it. The financial devastation from this crisis will be immense. There will be huge consequences associated with bailing out the corporate sector, for example.

The corporate bond market has taken the same hits as every other risk market. But it has hitherto been spared much of the severest of body blows that have affected equities because of its illiquidity and difficulty in finding a clearing price (if there is one).

The very nature of the structure of the market – corporate balance sheet ‘strength’ allows for debt servicing for a while – means that there is a lag before we see which entities will be caught as the tide goes out.

That fear and panic means that spreads have gapped. There’s an oft-used phrase that ‘the market is broken’. Well, it is.

The shape of the credit curve’s spread trajectory, uncannily, is following the same exponential curve trajectory that the coronavirus’ path is taking once it spreads in any given country. The recovery will come too, but once we survey the corporate casualties, the recovery trajectory might not be as symmetrical.

The corporate bid lists are out – aka 2008, for those who remember. As things stand, the market is offered only and there is barely a (decent) buy interest for a bond in sight. Secondary cash market liquidity is shot. We’re seeing a massive weakness in spreads as a result, exacerbated by that illiquidity. But we’re not at 2009 levels, yet – and we might not get there in the main corporate bond markets. It’s too early to tell.

The chart below shows how the euro-denominated IG spread market has moved this year, and, at the close of business on March 16th, the IG spread had gapped further to B+205bp, and are 103bp wider now this year. Returns continue to decline and currently sit at -3.4% in the year to date. We don’t think spreads in euro IG will test the 2009 wides.

High yield markets have similarly felt extreme weakness. The correlation with equities and macro is greater for these high leveraged sub-investment grade rated companies. The index is bp wider at B+747bp (March 16th) so far in 2020 (+400bp), after a 87bp widening in Monday’s session. Once again, we are unlikely going to test the record wides.

That suggests a default rate in excess of 8%. The massive easing in policy that we saw in 2008 following the financial crisis managed to limit the global default rate to below 13%. We would think that the market’s massive expansion in the period since (weaker covenants, more lower rated entities etc) will quite possibly see the default rate jump close to those levels. How far the rate eventually jumps will depend on the macro recovery dynamic and the level of government assistance given to companies.

The contingent convertible product is designed to fail and not trigger a bank default in extremis. And they will, in some cases, fail – perhaps in many situations. The 15% returns of 2019, and the 3%+ returns in the period to mid-February this year have all been undone by Covid-19.

In the opening session of this week alone, the AT1 iBoxx index widened by 240bp to a record wide of B+1084bp! We look for the index to widen to B+1500bp at least. Current returns are -16.6%, year to date. Awful.

We’re yet to reach peak virus in the UK. That isn’t too far away and it is likely that the worsening headlines around that will continue to see a very weak corporate bond market. We don’t think, as in the euro IG market, that we will necessarily see the record wides observed in 2009 in the sterling market, however. The index closed at B+234bp (+23bp) on Monday, returning -4.7% this year.

All the data is supplied by Markit iBoxx

There might have been a partial recovery in European equities into the close, but we didn’t see any of that in the US. It went from bad to worse. The Dow was 3,000 points lower (-13%) and the S&P -12% at the close of play. Losses accelerated after Trump gave an erratic press conference towards the end of the session. The VIX was 25 points higher at 82%!

Other markets saw the FTSE close 4% down, the Dax -5.2% with most other European bourses lower by in excess of 5%. The same again is likely on Tuesday if only to play catch up to the losses in the US.

Rates were better offered across Europe where the yield on the 10-year Bund rose to -0.47% (+12bp) and that was replicated across most European government bond markets, but the US Treasury market was better bid, with yields declining in the 10-year to 0.74% (-21bp).

Liquidity in the credit market came courtesy of the default swap market. And investors were busy buying synthetic protection which saw iTraxx Main up at 120bp (+8.5bp) and X-Over over 80bp higher at 609bp.

We’ve added a current yield calculator for those of you who might find it useful.

Good luck.

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.