5th August 2016

No one taking away the bowl

MARKET CLOSE:
FTSE 100
6,740, +106
DAX
10,228, +58
S&P 500
2,165, +1
iTraxx Main
68.5bp
iTraxx X-Over Index
324bp
10 Yr Bund
-0.10%, -6bp
iBoxx Corp IG
B+125.7bp, -0.5bp 
iBoxx Corp HY Index
B+457bp, unchanged
10 Yr US T-Bond
1.51%, -4bp

More of the same, but it won’t work…

rate-cutThe BoE didn’t quite kitchen sink it, but they have given it a mighty shot in the arm. It’s more of the same medicine though. It didn’t work before and we don’t believe it will work again. Still, they lopped 25bp off interest rates with a purchase programme taking in an additional £60bn of Gilts and £10bn of corporate bond purchases. For the corporate bond purchases, they’re directly feeding the “haves” – those who have ready, easy and relatively cheap access to the market.

The purchases might be designed to specifically help those who make a significant contribution to the UK economy, but indirectly all will get some help from the crowding-out effect. However, in a market not blessed with much supply as it is  – barely £7bn this year (Dealogic data) – and having always suffered from poor secondary market liquidity where the information ratio is also very poor, the BoE has just made it worse.

They’re not fixing this market, instead they are going to annoy and frustrate investors (just like the ECB are doing in the euro-debt market). On the plus side, sterling corporate bond returns are going to the moon, so there is some near-term consolation. In the first seven months of this year, investors were sitting on a superlative 13.2% returns and that has just jumped to 14% year-to-date following the rally in both the Gilt and corporate bond markets in the session. The Vodafone 49s (a 33-year deal issued just on Monday) rose by a massive 8-points!

In addition, we do not believe that lower funding costs will necessarily boost issuance. Why should it? Taking a cue from the Eurozone, supply hasn’t necessarily picked up with the YTD run rate at around the average level of the past few years. Corporates are already playing it defensive amid problems around putting money to work in an economy (UK and Eurozone) with an uncertain outlook – to say the least. After all, rates haven’t been cut by the BoE, nor are they at -0.40% in the Eurozone – with both also on a QE grabfest, because the outlook is bright. Corporates raising more (even if it is cheap) debt just means additional cash on balance sheet to manage – and that brings its own headaches.

So sterling corporate bond spreads rallied hard. The Markit iBoxx sterling corporate bond index tightened by 8bp to G+154bp and the index yield crushed lower to 2.53% (-23bp). That is the lowest index yield in history for sterling corporate bonds while the spread is now just 24bp off the record low seen in March last year (G+130bp). We think it will get there, because a £10bn QE programme is massive in terms of the dynamics of the sterling-denominated corporate bond market.

While cold turkey isn’t going to be a pretty sight

At one point this week, 10-year JGBs had lost almost 30bp following market disappointment that the right kind of further easing wasn’t coming from the BoJ. The broader point, which we have made over again, is that when the market either goes “cold turkey” on policy disappointment – or we head into the eventual “turnaround”, then it is not going to be a pretty sight. That JGB reaction will not be a patch on what will happen to government bonds in the Eurozone or to valuations in the corporate bond market. Negative yielding government and corporate bonds might be our norm right now as we chase capital appreciation strategies to offset that loss off/reduced income stream; and we might be chasing bond markets severely manipulated by central bank QE policy activity, but the backlash will be immense.

There might be tepid signs of inflation, occasional better-than-expected economic data prints and hard but short rallies in markets – but generally, we are underwhelmed by the lack of sustainable and material progress as far as macro is concerned. High debt burdens everywhere seem to be difficult to reduce or get under control except through monetary policy keeping default rates low by keeping servicing burdens de minimis. The bowl stays in place.

Non-farms coming up next

non-farms-payroll

Potential game-changer: Today’s non-farms payroll number

The non-farms payroll number is out later today and it could be a game changer. There’s not long to wait. Meanwhile, this week has all been about the BoE, while the earnings season in full flow has actually generally been decent. Equities generally have had a mixed week, government bond yields had given some back but the BoE move saw them move sharply lower again. The outstanding performance in the session came from Gilts. For example, the 10-year Gilt yield closed at around its record low at 0.64% (-15.5bp), while the 30-year Gilt moved almost 4 points higher. This all gave a “pick-me-up” to other government bonds and the equivalent Bund yield dropped to -0.10% (-6bp). Spanish yields dropped 7bp to 1.02% and once again it was in touching distance of its record 1% low.

In credit, we have had just two non-financial corporate deals this week, taking €1.75bn between them. Yesterday, EDP printed €1bn in a long 7-year deal at a measly midswaps+113bp – and for a 5-B credit, that’s incredible (coupon 1.125%)! Still, what the ECB wants it usually gets – and the compression trade (high/low beta) is well and truly on again after a 2-year absence. Trade and position for it. EDP debt is ECB eligible and the central bank already holds 5 other issues from this borrower. IG credit inched better for choice, with the Markit iBoxx IG index left at B+125.7bp while the yield on the index fell to a record-equalling low of 0.87%. However, the story wasn’t here. It was with sterling credit risk (see above). In HY, the market closed unchanged, but the index yield fell a little to 4.10%. It would seem like this particular market isn’t yet feeling the kind of love being dished out in high-grade markets.

That is it. Back on a weekly basis through August, on Tuesday. Have a good weekend.

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.