9th Nov 2015

Credit cycle.. What credit cycle?

MARKET CLOSE:
FTSE 100
6,354, -11
DAX
10,988, +100
S&P 500
2,099, -1
iTraxx Main
71bp
iTraxx X-Over Index
294bp
10 Yr Bund
0.69%
iBoxx Corp IG
B+150.3bp, -1.2bp 
iBoxx Corp HY Index
B+464.5bp, -4bp
10 Yr US T-Bond
2.33%

Credit cycle no more…  The differing rate outlooks are being interpreted as telling us that the credit cycle is no longer co-ordinated between regions. The assumption here is that there is a credit cycle at all. Higher rates/tighter policy likely in the US, lower rates/looser policy possibly coming in the eurozone and China/Asia steered the same way as the latter suggests a breakdown in the global linkage of the “cycle”. There may still be the vestiges of one in the US, but we would argue that the credit cycle as we have always known it is broken, as we continue to try and make sense of the global economy. We are in uncharted waters. That’s what the central banks’ manipulation of markets through massive monetary easing has brought us. To save the world from collapse, we had concerted and unprecedented loose policy as the central banks kept the global economy afloat and prevented a catastrophic financial collapse. That started 7 years ago. The politicians have failed in their duty since then (lack of real structural reform). Anyway, we have the prospect of a rate hike in the US in December and a possible cut in the eurozone (or something else) around the same time. The traditional view that the European economy follows the trajectory of the US one – but with a 6-9 month delay – no longer holds, we believe.

Euro-denominated credit should beat dollar risk… That means higher underlying yields in the US will eat away at total returns in corporate bonds, whilst lower yields here will help support returns. On the other hand, if the economy is improving in the US (and it is sustainable), then that ought to help spreads tighten more than they might in the eurozone (on the back of improving credit metrics). That is, benchmark funds in the US should outperform euro-denominated ones. So far, classical relative value dynamics between the two asset classes. Sterling corporate bonds fit somewhere in between. However, the additional toggle factor comes from demand. Lower yields in the eurozone (ECB buying more government bonds and/or increasing the scope of the buying programme to corporate bonds) will just bring greater demand for corporate debt. So spreads will tighten, as there will in no way be enough supply. That will help benchmark players. As an aside, the tighter the spreads and the lower the yield the more violent the volatility and market swings – this is a given! There might also be greater M&A in the US (although it looks like it may have topped out) if CEOs believe they have turned the corner, which is another reason to broadly stay steered towards euro-denominated corporate bonds. As for Asian/EM assets, there has been and will be further fallout on higher US rates. Generally we would stay away, but we recognise that some of the bigger blue-chip like companies based in the emerging markets will offer good value and opportunities. Do your credit work, but be prepared for some mark-to-market losses.

Whopping payrolls sets course for a hike in December… So US Treasury yields jumped higher and dragged eurozone government bonds with them, though by less. We still have much resistance to higher yields. The difference between the 10-year Treasury/Bund rose too, to a record high of 167bp, before settling back at 164bp. Recall, we suggested 200bp is a real possibility. Friday’s response to the huge payroll number was initially euphoric: the prospect for higher rates was ignored and equities chose to believe instead that growth was more important and that the US will help lift the global economy from its quagmire. Into the rest of that session and over the weekend, it was about how the Fed will control the pace of subsequent increases. US stocks closed flat on Friday, European stocks were higher with the DAX taking the lead and corporate credit ended the session tighter. We had a new deal from Sanef (10-year, Eur600m), with the supply total limping over the Eur4bn MTD level. The Markit iBoxx IG corporate bond index was lower at 150.3bp while the HY index managed 4bp of tightening to B+465bp. Main and X-Over were little moved, up slightly at 71bp and 294bp respectively.

So what does it all mean?… We think equities may have had their big moves for this year. They will be left in a range not too far from where they reside right now. Small ups and downs – meaning +/-2% like moves intraday (their new normal where we don’t flinch); but there is little to halt the better bid and overall solid demand for corporate bonds. We would prefer euro-denominated corporate bonds versus dollars and we would continue to take on a higher-beta risk positioning bias. When the market settles (and it will), we will see Treasury/Bund yields diverge some more. Corporate bonds in euros will be looking cheap – again. The change might come, one day, but that will depend on when we see some stability and recovery in the macro situation. Alas, when the credit cycle returns…

Chinese imports fell 18.8% yoy in October and exports declined almost 7%, figures realised on Sunday showed. For September, these were 20.4% and 3.7% respectively. Euro area GDP numbers for Q3 are this week, and we have US retail sales and the Michigan consumer sentiment survey to look forward to. Have a good 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.