18th March 2020

🙈 Spread Charts Have to be Seen to be Believed

MARKET CLOSE:
iTraxx Main

135bp, +18bp

iTraxx X-Over

700bp, +100bp

🇩🇪 10 Yr Bund

-0.23%, +20bp

iBoxx Corp IG

B+245bp, +25bp

iBoxx Corp HY

B+860bp, +65bp

🇺🇸 10 Yr US T-Bond

1.25%, +25bp

🇬🇧 FTSE 100 6104.73, (+1.71%) 🇩🇪 DAX 13066.54, (+2.36%) 🇺🇸 S&P 500 3431.28, (+0.67%)

Helicopter money on stand by…

We’re beginning to see the first vestiges of the coronavirus storm’s impact on macro with data emerging ex-China, and the readings are going to look as bad (if not worse) as we might have feared – with big demand/supply-side shocks. The current numbers have merely set a marker for what’s to come.

To their credit, authorities have reacted – on an unprecedented scale. And that initial market reaction (on Tuesday) might have left many to think that, having essentially kitchen-sinked it, we would have been close to establishing a floor. That exuberance was completely offside. The almighty sustainable bounce looks like it is some time away.

Unfortunately, we’re now getting the first reports of second wave effects emerging in Asia, suggesting possibly flawed strategies around suppressing the virus. It might be that until we develop a vaccine or develop a herd immunity (going along with the science), then we potentially remain at risk. So market volatility is with us for a while, and we are likely to discover a few more floors yet.

That comes as we just enter a fresh ‘market phase’. Needing to meet fund redemptions, or otherwise, the dash for cash is heaping huge pressure on the government bond markets. The printing presses are unleashing a large, blanket fiscal-expansion tsunami of debt which will need funding, and rates are backing up.

That debt might normally have been viewed as being a safe-haven class of asset, but when needs must, cash in its purest form not only becomes King – it’s the Queen, Jack, Ten and Ace too – akin to a full house.

Stating the obvious, economies are in big contraction mode, and we will eventually see a series of recessions registered – and we think that will include a global one, by the end of Q2. How bad – long and deep – it ultimately gets is anyone’s guess at the moment. We’re wracking our brains in trying to figure out when/how/what the other side will look like.

There used to be comfort with the herd

In credit, we’re scratching our heads as well. Surprisingly, some are still talking/thinking in terms of primary windows opening (for however long) and opportunistic borrowers using them to get deals away. And investors in some cases being prepared to get involved suggesting that there’s demand for deals.

At the same time, they have their pick of ‘cheap’ bonds as bid lists galore do the rounds and some look to sell what they can – and there are enough corporate bond fire sales to satiate their interest. But no. They either do not have the confidence to pick off paper that will likely be cheaper than an equivalent new offering, are not looking hard enough or, prefer to seek comfort with the herd.

It’s not as if we know the equity story, the drop in oil prices by around 70% from the 2020 highs, the recent drop in gold and various currencies versus the dollar and Bitcoin/Crypto. As if it could – and it can – credit markets are going to worsen and potentially by a material amount from now.

In secondary, we continue to gap significantly. Spreads across the board are under heavy pressure, the bid lists circulate and high beta markets, in particular, are in panic mode.

Interestingly, the trajectory in the high yield corporate bond market suggests that we are not going to see the levels (or anywhere close to them) that we witnessed in 2009. That might be due to the promise of unlimited liquidity from the various governments to the corporate sector, the more timely action by them and the fund lock-in periods common cross the investment community.

The big back-up in rates in the session has also just added to the hammering total returns in credit and there is no safety net here, either.

IG credit, as measured by the iBoxx index, shows total returns year to date at -6.6%. The spread on the index is now wider by 142bp in the same period (see chart), having moved another 25bp wider on Wednesday to B+245bp. The sterling corporate bond index also widened by 25bp, to G+282bp, with returns in this longer duration market at -10%, year to date.

However, it is much worse in the higher beta markets, where the previous crowded trade had investors pile in and hoover up higher-yielding debt securities. They are now feeling the most pain.

The AT1/CoCo market is completely friendless. It was the darling of the market in 2019 – and even through the opening weeks of 2020. The casualties now are numerous.

Just to highlight some of the deals issued this year, the Erste Bank‘s 3.375% perp issue is down at €65 (-€35 in 3 weeks) and the Santander 4.375% is at €60 (-€40 in the same period). Add in pressure from managements/bosses, for example, to reduce risk to Italian debt especially sees the Unicredit 3.875% AT1 trading at around €52 (-€48).

For the index, we’re at the widest levels seen in this market during its short history, with spreads well over 1000bp wider this year, up at B+1500bp – our target! Well, B+2000bp is, unfortunately, the next stop.

There is some massive gapping in spreads with moves on the index in excess of 200bp per day this week, and total returns for the AT1 market year to date at -25%! It likely doesn’t improve anytime soon. The chart below shows the change in the index spread this year to date. Exponential.

And then there is the high yield market. It’s still being spared the punishment meted out in the AT1 market, but if macro literally collapses (likely), then this market will as well. For now, the iBoxx HY index spread moved just 65bp wider in the session amid zero real visibility, leaving the index at B+860bp.

It was a sorry picture everywhere. The FTSE closed 4% lower, the Dax by 5.5% and the €Stoxx50 6.2% with the US markets lower by anywhere between 5% – 7%. The markets are not going to be helped by Trump’s use of the term ‘Chinese Virus’ in his press conference.

In rates, the 10-year Gilt yield backed off, to 0.78% (+23bp), the Treasury yield to 1.25% (+12bp) and the Bund benchmark to -0.23% (+20bp). WTI was trading down at $21 per barrel after falling by 21% in the session, as at the timing of writing. For this product, $10 per barrel looks like the next stop.

Credit index was back in fashion with odd periods of respite when equities trade up. Buyers of protection helped the index rise to 135bp (+18bp) for iTraxx Main and by almost 100bp for the X-Over index, to 700bp at the close.

Be careful out there.

Suki Mann

A 30+ 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 CreditMarketDaily.com.