29th April 2018

Don’t look back in anger

MARKET CLOSE:
iTraxx Main

54.5bp, -0.1bp

iTraxx X-Over

271.7bp, -0.2bp

10 Yr Bund

0.57%, -2bp

iBoxx Corp IG

B+103.5bp, unchanged

iBoxx Corp HY

B+319.3bp, unchanged

10 Yr US T-Bond

2.96%, -4bp

FTSE 100 , DAX , S&P 500 ,

A cautious welcome…

In this final session of April, we should be looking forward to what May might hold for the markets. But we find ourselves looking back instead, on an incredible Friday which might have repercussions in several different markets.

We had the historic North/South Korean summit, a miss on French Q1 GDP, no news still on whether Europe will receive US import tariff exemptions, Trump’s trip to London confirmed, a big miss on UK Q1 GDP, and a sharply stronger dollar which might heap more misery on emerging market dollar funders. European equities rallied though on the weaker sterling/euro currencies versus the dollar and perhaps a little on the relief around the Korean summit. Rate markets joined in (on weaker growth data/prospect of extended ECB policy accommodation) while credit markets were knocking on the door trying to join the party – unsuccessfully.

Donald Trump deserves much of the credit (as well as the South’s Moon Jae-in) for getting the North Koreans to the table to engage in talks and potentially denuclearise. Whatever one thinks about the US President, he has potentially managed to reduce a large concern of the geopolitical event-risk equation many fretted about. It was a good time to announce that the US President would be visiting Britain in July, too. The historic meeting between the North and South deserves all the plaudits it received, though. It was political theatre at its best. Let’s hope they can all deliver on the promises made amid what appeared to genuine dialogue between the parties.

French GDP came in at 0.3% quarter-on-quarter during Q1, missing expectations of 0.4% and down on the 0.7% seen in Q4. That will tie into the more cautious tone echoed on growth by Draghi and is supported by the weaker data points coming from the Eurozone of late. As the hawkish growth outlook falters, there’s little reason for Eurozone rate markets to sell-off just yet – apart from any pressure they might receive from US rate markets.

In the UK, GDP also missed, coming in at +0.1% versus forecasts of a 0.3% rise leaving the quarter’s growth at the slowest level in five years. Sterling sank. Gilts rallied. In our view, a rate hike in the UK is off the table for 2018, as a May rate hike is now completely off the table.

The May 1 deadline for the imposition of steel and aluminium tariffs is just 24 hours away and the Eurozone’s political elite – as well as industry, is now fretting that they have failed to get an exemption and get dragged into a trade war, with France’s economy Minister talking about not becoming ‘collateral damage’ in what is predominately a US/China spat. No doubt Michel Barnier will be looking on as the UK Brexit talks have become a little more heated and perhaps nasty as negotiations on a/the customs union start to ramp up.

And then there is the sharply higher dollar, and talk now that it has legs in it yet for a further rally. After all, US inflation is on the up and the Fed is due to hike rates three more times this year. The FOMC meets this week although it is unlikely going to act on rates having hiked at the last meeting. So just as US bond yields are going higher, emerging market dollar funding corporates are going to feel a squeeze.

What does this all mean for credit? Unfortunately or not, a slower economic growth trajectory is actually a supportive variable for the corporate bond market in Europe. It means everything stays as it is – low default rate, low funding rates and continued demand for corporate bond risk which yields a little more than the risk-free rate. We’re not getting anywhere near enough supply in IG non-financial corporate debt though, and we should, therefore – or rather will, start to see better support for secondary leaving spreads to tighten. Or at least stay at around these levels.


Drunk on yield, & it’s some party

A €4.3bn of high yield issuance last week took the total for the month to €11.45bn. This market is the outstanding primary market story for 2018 so far. The interest for primary high yield is as good as it has ever been. There might have been a wobble on the sentiment front through Q4 2017 as investors showed some concern on secondary valuations and we had some pushback, but there are no such concerns now. We still have Monday’s session to come to add a little more to that total. Year to date, as we close out the first four months of 2018, has us at a stunning €33.6bn of issuance.

Compare that HY issuance above with just €1.3bn of IG non-financial (non state owned) corporate issuance, last week. At €14.45bn for the month, we must be disappointed with the low level of supply. The €69.5bn total for the first four months is simply just very low, inexplicably so. It’s a head-scratching problem as to why corporate bond spreads are not tighter.

The low rate environment – or should we say the resumption of it through April, ought to have extracted a greater level of deals in IG. And then in the high yield market. It seems we have just jumped the gun and gone straight to a proportionally higher level of high yield deals. Macro supports both – low’ish growth, low funding rates and a very low default rate – and the prospect of more of the same for the foreseeable future. We are not breaking out of any of those macro and technical support (supply/demand) factors anytime soon.


Rates still in the limelight

Amongst the GDP numbers mentioned above, we also had US GDP for Q1 which came in at better-than-expected annualised level of 2.3%, but still represented a slowing versus Q1 a year ago (2.7%) and Q4’s 2.9% growth rate. Most are still looking for the growth rate to be closer to 3% for the year. Sentiment data from the University of Michigan survey was also down, but slightly better than expectations. The US markets closed without really reacting in equities, while we had a broad bid for rate risk.

The 10-year Treasury closed at a yield of 2.96% (-3bp) and the Bund yield pulled back too, down at 0.57% (-2bp) while the UK GDP report saw a significant rally in Gilts to leave the 10-year yield at 1.44% (-6bp).

Government bonds might have been better bid, but it didn’t feed through into the credit markets. We might be lucky – and get a delayed reaction to that. Credit closed unchanged on Friday, leaving the iBoxx index for IG corporates at B+103.5bp and the high yield index at B+319bp and both a touch wider for the week.

As for this week, we have the FOMC announcement on Wednesday – it will come and go without too much brouhaha for a change. We close out with the non-farm payroll report on Friday (consensus forecast 198k additions) and we have Apple, Kraft and McDonald’s amongst the 150 or so companies reporting in the US.

Have a good day.


For the latest on corporate bonds from financial news sources, click here.

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.