16th March 2016

Believe it, it’s going to happen

MARKET CLOSE:
FTSE 100
6,140, -35
DAX
9,933, -56
S&P 500
2,016, -4
iTraxx Main
76bp, +4bp
iTraxx X-Over Index
328bp, +15bp
10 Yr Bund
0.31%, +4bp
iBoxx Corp IG
B+153.5bp, +0.5bp 
iBoxx Corp HY Index
B+535bp, +5bp
10 Yr US T-Bond
1.97%, +1bp

Time to revisit the tights… We went out with expectations that corporate bond spreads in investment-grade credit would tighten 24bp in 2016 to B+130bp and return 1.5-2%. But with the ECB in play, we are looking for spreads to be closer to B+100bp (Markit iBoxx index) from the B+153.5bp as of today. We are on course for 4%+ returns if spreads hit that 100bp level and underlying yields hold steady or go lower. The iBoxx index achieved a record low spread of B+95bp exactly a year ago, as well as a record low yield of 1.02%. Spreads will continue to tighten while the ECB bond buying programme is ongoing, and allied with continued weak economic data will keep the underlying (government bonds) anchored. Currently at B+153.5bp/1.50%, the old record low is under threat on both counts. And that’s a fund manager’s problem – or rather it will be, in 2017. It’s also a problem for pensioners, as well as for anyone else who is dependent on savings income. And it will become more of an issue in time as bubbles are maintained or created in other asset classes as liquidity chases yield – that is, riskier assets. Back to credit, and while it looks good for IG, the “push-down” effect will also benefit the HY market. S&P, we mentioned yesterday, suggested a below average default rate for 2016 (we think beyond), and we are of the view that the market for borrowers will reopen in due course. More supply will breathe confidence into the market and beget tighter spreads. It’s difficult to judge the spread outcome for high yield at this juncture, but the narrowing trajectory could see us materially tighter from here. Poorer secondary market liquidity especially ought to see a disproportionate movement tighter, and the current B+535bp could see the Markit iBoxx index closer to B+400bp and returns easily north of 5% by the end of the year. Single-name event risk will be the major hurdle – as always – given we don’t foresee a systemic issue derailing the high yield market.

Cash and synthetics: What do they tell us?… We commented previously that the cash market will now become very technical and that the synthetic (CDS) market might offer a truer reflection of the risks inherent in credit. That wasn’t always the case. We expect that CDS/iTraxx indices will generally continue to play out to the tune of macro news flow, headline and sectoral event risk and equity market volatility. Their liquidity will also offer a better opportunity to play directional trades for (short) periods, should one want to. We would therefore expect divergence between cash and synthetics, with the former outperforming and generating the expected cash/CDS basis impact. Unfortunately, relative value-positive basis trades as a pairing (CDS-cash) are difficult to put on, as few will want to short cash!

Primary order of the day… A plethora of issuance met us today. Lots of deals sized between €500m and €750m, and something in it for everyone. For the periphery we had Brisa in a sub-benchmark €300m, 7-year offering. FCA Cap offered up €500m in 4.5-year funding. Scentre Group also came with a 7-year for €500m, while RLEX (formerly known as Reed Elsevier) clipped €750m in a 10-year transaction. Thyssenkrupp was there for the HY market with a €100m tap of its 2.625% 2021 issue. All the deals were oversubscribed by 3-5x and final pricing tightened by 10-15bp versus the initial price talk. In financials there were a couple of senior deals from RBS and Deutsche Bank, while Santander lifted €1.5bn in a 10-year T2 offering. Finally, and in a surprising development, Transurban Queensland pulled their €500m, 8-year potential deal, citing volatile market conditions. Confused with that explanation? We were. We would think that there was some pushback by investors, reducing the potential for tightening versus that initial price talk, and the borrower deciding not to pay up having probably been “promised” a much better level; it’s not the best name in the world to get excited about.

Tranquility confined to corporate bond market… The stock markets finally ran out of steam and gave a little of the previous sessions’ stellar gains as they ended the session 0.6-1% lower. Oil prices continued to fall too, with another 2%+ drop leaving Brent at around €38.5 per barrel. Govies gave some back too with safe-haven bund yields higher – the 10 year at 0.31% (+4bp), while peripheral risk was also a little weaker perhaps on a bit of profit taking having witnessed a fairly significant rally of late.
There was little data to contend with, but we had Brazilian stocks off almost 4% on corruption scandals while Canadian drugmaker Valeant’s share price closed over 50% down. Its FOMC and UK budget day today. Nevertheless, in credit we played out flat to slightly better offered in the session. The initial euphoria is over, but the trend is clear in our view – tighter. Also, much focus was on the new issue market and although the overall non-financial volumes were down versus, say, yesterday, there were plenty of deals to look at. Finally, those poorer headlines and weaker stocks saw to it that the synthetic indices backed up leaving iTraxx Main up at 76bp (+4bp) and X-Over at 328bp (+15bp).

Have a good day.

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.