16th June 2016

Don’t rock the boat, baby

MARKET CLOSE:
FTSE 100
5,967, +43
DAX
9,607, +88
S&P 500
2,072, -4
iTraxx Main
86.5bp, -1.5bp
iTraxx X-Over Index
371bp, -4bp
10 Yr Bund
-0.01%, -0.5bp
iBoxx Corp IG
B+148bp, unch 
iBoxx Corp HY Index
B+507.5bp, -1bp
10 Yr US T-Bond
1.57%, -4bp

Waiting for the Fed brings calm to markets…

After an exciting few days, the FOMC managed to bring some calm to the markets, and this respite was well needed. Cash credit (including sterling) has held up very well into the malaise which has inflicted much pain on equity markets in particular. However, equities managed to claw back a little of the previous sessions’ losses, while government bond prices actually held firm as we awaited Yellen’s communiqué. That does not change the picture around stressed risk markets though, the flight-to-quality trade or the fact that the global economy is looking rather desperate. The UK referendum continues with the Leave camp firmly in the lead in the eyes of most opinion polls, but even this took a back seat to the FOMC.

It’s worth reflecting that while European equity indices have lost several percentage points since the middle of last week, investment grade corporate bond spreads have remained resolute (just a minuscule amount of weakness), while returns for the asset class – as for other fixed income markets – have improved. It’s not lost on us, and we have suggested it several times already recently, that weak macro will persist for a good while yet. This won’t necessarily be bad for the corporate bond market.

There is no white knight to help drag the global economy out of its current dire predicament and that includes any additional impact we might get from further easing measures (QE, in other words). The fact that the Fed has made a quick about-turn from dead-on certainty of a rate hike in June to the market now thinking that there might only be one (two tops) in 2016 highlights the many false dawns of economic recovery. Japan had this a hundred times over the past 25 years, but its weakness was manageable for various regions – not least because the global economy was otherwise mostly in fine fettle. Not now.

But corporate risk will continue to gain

We dare say or expect that equities will remain choppy. We’re over the Fed hump and we move on to Brexit next week and the Spanish elections a few days after that. There are enough near-term risks out there to suggest caution ought to prevail. brexitBut there is little (Brexit included) that we believe will blow the global economy out of the water. That is, in our view there is going to be no systemic crisis. Meaning the sort of financial crisis that would cause us all a severe headache. Macro might blow colder than we like, but at these levels of activity and even a little lower it will continue to maintain the attraction for corporate bonds. Debt servicing is as resolute now as it has been at any time throughout this crisis.

Corporate balance sheet and investment caution will continue to win out versus any mad dash for deleveraging because some M&A or investment opportunity frenzy might be looming. So Europe’s corporate bond market – and we include sterling risk here – is rightly well-supported, and not just because the ECB has rocked up.

Limited activity into FOMC

Primary saw just a tap for €300m from Holcim of its 28s in the IG non-financial space, while Verallia Packaging was tapping its 2022s for a further €200m in the high yield market. We’ve been impressed by the constant stream of HY activity in primary since the ECB started getting involved, while the IG market has completely underwhelmed. There was nothing in senior, the rest being a covered bond issue and a T2 dollar issue from Aussie insurer QBE. The secondary market offered little too. Spreads in IG closed unchanged as measured by the Markit iBoxx index and the index yield was also unchanged at 1.21%. The high yield market closed pretty much unchanged. The indices – where activity has rocketed of late, recovered a touch with Main lower at 86.5bp and X-Over at 371bp.

No straight line collapses. Equities gained ground with the DAX up 0.9% (but well off the session highs) with most other bourses up by a similar amount  – including the FTSE (+0.7%). Government bonds started the session a little weaker but recovered that weakness and closed slightly better bid. The 10-year Gilt was its closing record low yield of 1.12%. Oil was stuck below $50 with the Brent contract trading off a $48 per barrel handle late into the session.

Sensible Fed doesn’t rock the boat

Federal ReserveAnd finally, the Fed. No rate rise and at most – as they see it – we might get two this year. Fat chance. We’re not holding our breath and neither is the Treasury market as the 2-year yield fell 5bp and the 10-year 3bp, seeing 1.57%. All is not rosy in the garden. Stocks ought to have rallied hard, but they didn’t because the outlook is potentially strained (if not bleak) such that corporate profits will remain under pressure. Low funding costs are bit of a back seat driver now (annoying and not effective) in that sense.

What can we expect as we open for business today? Little movement in stocks probably as uncertainty grips (lower we suspect), but perhaps a better bid for government bonds – and yes, that means lower yields; and corporate spreads kind of languishing in no man’s land. Primary ought to be light.

Have a good day. Back tomorrow.

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.