9th December 2016

Draghi the Tinkerman is back

MARKET CLOSE:
FTSE 100
6,932, +29
DAX
11,179, +193
S&P 500
2,246, +5
iTraxx Main
xx.xbp, +-xbp
iTraxx X-Over Index
xxxbp, +-xbp
10 Yr Bund
0.38%, +4bp
iBoxx Corp IG
B+135.8bp, -1.5bp 
iBoxx Corp HY Index
B+431bp, -3bp
10 Yr US T-Bond
2.41%, +7bp

More manipulation, they’re in it deep…

ECB President Draghi extended bond buying until next December

The ECB left the markets with much to ponder. This wasn’t as simple a meeting as we had hoped it might have been. What’s wrong with just extending and reducing? Nope, they just had to tinker a little more. And net net, they probably eased policy some. They’ve thrown in cash for use as collateral in the repo market and decided that they can buy debt yielding less than -0.4% (that’s the deposit rate which stayed unchanged).

They took away with one hand and gave with the other. The ECB might have kept liquidity conditions easy, but they probably have engineered a steepening of the yield curve as they potentially buy less longer-dated debt. That helps the banks.

Tapering? Here the jury is out. They’re reducing the monthly purchases from €80bn to €60bn but the programme was extended to December 2017 with the likelihood of it being extended beyond that date. Now we’re thinking that in due course they will extended beyond December to, say, June 2018 – and reduce the purchases to €40bn. A taper with the longest of tails. However, that hypothesis will depend on how the economic situation looks in Q3/early Q4 next year. So tapering, yes – but not as we know it.

With economic risks skewed to the downside, according to the ECB, and inflation remaining stubbornly relatively low (They reduced their forecasts significantly for 2017 to 1.3% from 1.6%, and to 1.5% in 2018 from 1.6%), there is some good news in there for those fearing materially higher yields next year.

For sure, intermediate and longer-dated Bund yields are going to rise, but these forecasts have likely staved off a catastrophe for fixed income (credit and government bond) investors, especially as the ECB will need to stay vigilant around Brexit, Trump post-inauguration, the evolving political situation in Italy, French elections next May and then the German elections in September 2017. Fear not, yields will not be heading to the moon in double-quick time.

So, selfishly, from a fixed income investors performance perspective for 2017 there is no disaster in the ECB’s latest attempt at manipulation of the markets. Overall, policy stays easy and accommodative through 2017. We get a steeper yields curve so the banks get a leg up. Longer-dated yields move higher but in measured fashion but they might just play out in a 0.3-0.6% range through next year given the likelihood of “other” events – as mentioned above – supporting the bid for safe-haven assets.

Equities rallied, knowing liquidity conditions stay supportive and we have a moderate level of growth to help the corporate sector chug along. Corporate credit quality ought to stay rock-solid and the default rate low through next year.

Corporate bond spreads might have sold off initially but as we reflect, the changes to policy will not have blown the corporate bond market out of the water.  A return to sustainable higher economic growth will do that, one day. Spreads came back off the session wides.

Wild horses couldn’t hold us back

German stocks having a good end to the year

The Bund yield reacted to the ECB and immediately steepened. The 2-year yield fell to -0.77% (-7bp) while the 10-year closed (off the highs) at 0.38% (+4bp). Italian yields rose, the 10-year BTP left at 1.99% (+11bp) while the equivalent maturity Bono closed yielding 1.50% (+8bp). Portuguese government debt was the day’s underperformer, the yield on the 10-year at 3.70% (+23bp). The euro weakened against the dollar, reflecting the ongoing accommodative policy and view that the ECB had  eased policy.

As for equities, the DAX has moved higher and raced through 11,000. That’s a little late in the year but it has shot higher in the past couple of sessions like a thoroughbred coming up late on the rails into the final furlong. 11,179 – which is where the DAX closed yesterday – is the highest level for 2016 so far and much higher than the 10,743 level we started at. Most other bourses moved 0.5-1.2% higher.

Secondary corporate bond spreads ended the session tighter. As measured by the cash Markit iBoxx index, we closed at B+135.8bp (-1.5bp) while the index yield only dropped a basis point owing to the rally (at the front end) – or not (at the longer end) – in the underlying. Spreads in sterling moved 1.5bp tighter too, the iBoxx index at G+157.5bp – and the index yield dropped a basis point too, to 3.12%!

The shorter duration nature of the HY market made for it being the big winner, given the rally in the front end of the government bond curve. Spreads tightened only 3bp to B+431bp for the iBoxx index. The index yield fell to 4.07% but returns will have shot higher (they did, now up at 7.4% YTD). As for the synthetic indices, iTraxx Main closed at 74bp and X-Over at 315.5bp – both unchanged! The only deal of the day came from Schustermann & Borenstein for €260m in the high yield market.

That’s it. Have a good day and also weekend. Back on Monday.

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.