24th October 2016

Draghi is misinformed

MARKET CLOSE:
FTSE 100
7,021, -6
DAX
10,711, +9
S&P 500
2,141, unchanged
iTraxx Main
71bp, unchanged
iTraxx X-Over Index
320bp, unchanged
10 Yr Bund
0.00%, unchanged
iBoxx Corp IG
B+122.75bp, unchanged 
iBoxx Corp HY Index
B+412.75bp, -3bp
10 Yr US T-Bond
1.73%, -2bp

He ain’t fooling us…

It’s NOT because of the ECB’s QE corporate bond purchases that issuance (net) in September may have picked up – as suggested was the case by Mario Draghi. To us, it is complete coincidence that it might have, because the year has been anything but normal in terms of market conditions for issuing. Gross issuance for September was lower in 2016 versus both 2014 and 2015 (see chart, below) while the net figure will be up or down at the margin. The worrying aspect of it for the ECB must be that with funding levels stuck at record low levels we ought to be seeing a much clearer high level of supply. We ain’t.

We saw very little primary market activity in January and February (normally heavy months) but several €40bn+ months in IG non-financials since, as the market played catch up. October, for instance, has seen just €12bn on IG non-financial issuance and that’s a very low level.  However, we think this week could see a decent level of supply to take that to close to the €20bn mark for the month.

If it does not happen next week, November could be a very busy month when just looking at the numbers – we have BAT ($47bn unsolicited offer for the remaining stake in Reynolds) and Danone potentially doing some big deals – but this won’t be down to the ECB providing a nudge to get them done. It will be more about coincidence. Issuance levels are going to have to accelerate some if Draghi is going to feel vindicated and make the same comment about issuance in his December press conference.

Gross IG non-financial monthly issuance

“It’s the economy, stupid”

Where the ECB’s QE has helped, though, is by providing a platform for sustained low funding costs for the corporate sector (not that they needed it). Nevertheless, the IG community hasn’t necessarily taken advantage to get additional funding in – but rather taken the opportunity to refinance more aggressively while the more favourable conditions persist. After all, more low cost funding is always attractive, but the booty needs reinvesting. We don’t see a noticeable pick up in investment, M&A or capex and the like. Instead it is left on balance sheet, and can become an headache if yields keep going lower as it adds to the corporate treasurers’ reinvestment risks.

Markets finding their feet?

After a couple of weeks of unnecessary speculation and concern around the ECB, we’re likely heading into the same kind of market conditions again with the FOMC coming up. There’s been a bit of slipping and sliding and it has left us in some sort of no man’s land as to how we can push on from here. Too many sessions are passing us by as we manoeuvre this inflexion point. Last Friday’s session played out in the dullest of ways with equities barely moving, government bonds effectively unchanged and credit markets doing very little too, albeit a tad better bid.

Stunning: BAT's takeover bid of Reynolds

Stunning: BAT’s $47bn takeover bid for Reynolds

The news flow was around BAT’s courting of Reynolds for the $47bn (currently valued by BAT) interest it doesn’t already hold, while bond investors will be looking forward to Danone’s multi-tranche deal to come. That potential BAT/Reynolds deal wasn’t the only one to lighten up the day in the US, with talks between Time Warner and AT&T thought to be well-advanced too.

Earnings were mixed but we would think slightly better than expected overall (GE, McDonalds with Bombardier announcing 7,500 job cuts and Honeywell missing) and Deutsche Bank was finding some support amid reports of “investor interest” in taking a stake in the bank.

Portugal managed to keep its investment grade rating from DBRS, and so interest from the ECB in its debt will be maintained for a while longer. Portuguese paper was trading a little higher in the session to yield 3.16% (-2bp) for the 10-year, but a bigger move might come today, given that the rating affirmation came after the market had closed.

Otherwise, 10-year Bund yields ended the week at 0.00% (unchanged on Friday), the equivalent Gilt yield was up a basis point at 1.09% with little really happening in limited session. Equally, stocks did little too, although we again point to the DAX index, up 9 points and 34 points off being flat again, YTD. We’re willing it on!

Credit steady again

A dull session to close out the week delivered nothing in primary save for a couple of covered bond issues. So we ended the week with just €2bn of IG non-financial issuance – from four borrowers, while TUI was the sole flag-bearer for the HY market with a €300m issue. Not great. According to our figures, the HY supply for the month is now up at €2.45bn from eight borrowers.

Admittedly, and as stated previously, the pipeline is bulging, and maybe the Danone deal could come this week to help get some numbers on the board, but more importantly some cash invested. The deal might be multi-tranche – but it won’t come cheap given the level of demand there is.

Secondary credit closed on Friday slightly better bid in high yield and unchanged for both sterling and euro-denominated IG credit in a lacklustre session. Those moves kind of reflected what we saw for the week as a whole. The HY Markit iBoxx index was 12bp in the week versus 7bp lower in the week before and 15bp three weeks ago. Not quite the comeback kid, but better than the grind we are seeing in IG credit. That’s because non-financial IG credit was just 1.25bp tighter through the week at B+122.75bp, although the index yield was 5bp lower at 0.93%. The spread levels for both indices are the lowest that have been for over a month and corporate bond spreads have shown little desire to move anything but tighter – however excruciatingly a grind it might have become. It is unlikely going to change this week, especially if we get a high level of issuance. Even sterling corporate valuations edged better in the week.

We have another busy week ahead on the earnings front with some bellwether industrial giants from he US due (Dow Chemical, Caterpillar and GM for example) alongside Apple and ExxonMobil. UK GDP for Q3 will take in all the fuss around Brexit while we finish off with US Q3 GDP on Friday. We’re also into month-end, and we think investors will be looking to protect returns, so turnover in the corporate bond market will probably lighten up some more!

Have a good start to the 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.