16th August 2016

The day the music died

FTSE 100
6,941, +25
10,739, +26
S&P 500
2,190, +6
iTraxx Main
iTraxx X-Over Index
10 Yr Bund
-0.08%, +3.5bp
iBoxx Corp IG
B+121.5bp, -0.5bp 
iBoxx Corp HY Index
B429.5bp, -6bp
10 Yr US T-Bond
1.54%, +2bp

They could also be going zero…

Actually, they may well go negative. Everything else is heading that way. And it is no longer a “big call”. We’re talking 10-year Gilt yields, that is. The supply and demand dynamic is going to stifle the BoE’s Gilt grab – and while they will face an uphill task to get their £60bn of purchases, the BoE might think that much of the job is done anyway. Because they will have managed to get yields materially lower thereby reducing funding costs for a whole host of market participants. However, we believe they will not have succeeded in channeling any material extra cash into the economy. Some you win, some you lose in another central bank policy initiative that smacks of more market manipulation. But this is also a policy which hasn’t worked to date – for the BoE previously, while the jury is out as far as the ECB is concerned and in the US, the massive QE the Fed embarked on several years ago has had questionable results so far. Last week’s PPI and retail sales figures show that the US not immune from the general global economic malaise.

Anyway, a sustained low yield environment in the UK is going to be a god-send for the heavily indebted, but there are problems building in many quarters. A case of unintended consequences. For example, over the past 20-years or so, massive policy pressure – from a structural perspective, has been put on pension funds/insurance companies (the predominant holders of long-term Gilts) to make sure much of their long-term liabilities are matched. It’s no small wonder that they daren’t sell (hence the squeeze), while the capital gains from the massive Gilt rally offer scant consolation.

With all this in mind, we are predicting that 10-year Gilt yields will likely be heading into negative territory, even if the base rate does not move from these slightly positive levels (we think policy rates will go lower, eventually). They saw a record intra-day low of 0.50% in yesterday’s session, before giving some back into the close. It might take into Q1 or Q2 2017 therefore before we get into single-digit territory or less, but few had believed Bund yields would be residing in negative territory out to 10-years. Elsewhere, the precipitous drop in Spanish yields has us looking at another possible candidate sometime in 2017. Admittedly that prospect might seem a long way off, given 10-year Bonos currently yield 0.93%, but… peripheral government 10-year debt offering a negative yield? Even Elvis would be turning in his grave.

Sterling corporate rally ends, euphoria fades

BMW, BP, Vodafone (again) and Places for People alongside several bank issuers fed into the upbeat tone for sterling corporate risk in the few sessions following the BoE’s rate cut and QE announcement. As mentioned, Gilts have seen record low yields, and IG sterling corporate bond indices (all of them) have recorded record low yields, while spreads crunched tighter – a week ago. The markets have since repented a little at leisure – given a little back or stabilised, but we do expect a renewed push better again into the end of the year. Looking at the data, the 18bp of tightening in the sterling Markit iBoxx corporate in the aftermath of the announcement has failed to develop, and spreads actually closed last week a a little wider. The new 40-year Vodafone deal tightened almost 20bp on the break but is now around 10bp wider versus reoffer, for example. The corporate bond index yield – courtesy of the continued Gilt rally – has dropped 25bp to a record low of 2.28%. Index total returns YTD sit at a touch under 17%.

Away from the sterling bond markets, there is no stalling in the euro-denominated markets as spreads there continue to grind tighter and index yields continue to set new record lows as each session passes. Our target for the Markit iBoxx IG corporate index yield is 0.70% and we are not far off that now – with the index yielding a record low 0.83%. The next step of the heavy lifting to help get us there ought to come from the corporate spread component. Our target into year-end is around the B+100bp level for the iBoxx IG index which currently resides at B+122bp. This index has tightened by 6bp in the first two weeks of August – helped by the ECB’s ongoing corporate bond shopping spree, and 32bp in the year to date – having been up at B+190bp area during the dark February period.

That ECB’s shopping receipt showed that €1,248m was accumulated last week, and €16.2bn in the nine weeks since it all began. That is the lowest weekly lift since the €1,365m they bought two weeks ago. The weekly average has now dropped a touch to €1.8bn. It would appear that seasonality (holidays) has also impacted the ECB’s ability to find enough sellers. If this is the case, we can expect similar or less over the next two weeks.

Issuance has not been as light as expected

The new issue activity this month has been quite sprightly, largely because we’ve had several deals in the sterling market (see above), but the euro-denominated debt markets have been showing some form too with EdP, Cellnex and Shell giving us €4bn of IG non-financial issuance. The banks have been active with AT1 deals (in dollars) too with several sterling senior transactions feeding into that sterling-like frenzy. We do not anticipate much will be added now give that these next couple of weeks are the peak holiday season, although frequent borrowers with easy to get away deals might be tempted. Other than that, we are looking at the starting gun for the end of the month/early September for borrowers to get deals away into or before the likely traditional September rush gets going. Don’t expect much (if any) non-financial corporate issuance over the next two weeks.

Promising to be an interesting run-in

The run into year-end will begin in earnest at the beginning of September. That is when we would have had enough time to ponder the ECB/BoE dual QE actions and their impact on the corporate bond markets. There have been some signs of an inflation pick-up while the data has been extremely mixed – and we include the US here. Nevertheless, as we head into September all eyes will be on primary and we suspect a few looking to get whatever bonds they can as coupons continue to decline. Few will be concerned that a reversal (growth, rotation) is imminent and will trade therefore into expectations that the current Goldilocks economy will persist through 2017.

The equity is recovery complete with the DAX pretty much flat now YTD having had a super few weeks clawing back losses of around 12% as things stood in July, or from over 18% of index losses back in February. In the US, it’s record highs for the S&P and Nasdaq, while Treasuries are holding firm at just above the 1.50% yield level for the 10-year. In Europe, we closed with government bonds edging lower (in price) such that 10-year Gilt yields rose to 0.53% and the equivalent Bund to -0.08%. There’s bit of a summer break in the markets now and so moves will be exaggerated in either direction while participant and activity levels decline markedly.

On a housekeeping note, we’re only publishing on Tuesday’s in this holiday month. 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.