17th June 2018

ECB gives credit a leg up

MARKET CLOSE:
iTraxx Main

65.6bp, -0.3bp

iTraxx X-Over

293.0bp, +1.4bp

🇩🇪 10 Yr Bund

0.40%, -4bp

iBoxx Corp IG

B+124.5bp, -0.7bp

iBoxx Corp HY

B+375bp, -1.6bp

🇺🇸 10 Yr US T-Bond

2.92%, -3bp

🇬🇧 FTSE 100 , 🇩🇪 DAX , 🇺🇸 S&P 500 ,

Time to roll up those sleeves…

The ECB has given every reason for credit markets to get bullish for the next 9 – 12 months. They’re not moving on rates. Admittedly, QE is ending, but fundamentals remain supportive and technicals will take on a different – but also supportive – dynamic. The bid for rates makes credit even more attractive. US rates are cheap (with the 10-year stuck in  2.75-3% range) versus Bunds/Gilts/JGB markets and the 10-year there has a solid bid behind it, adding to the flattening of the curve. Higher US policy rates might dampen inflation levels over the medium term, too. Credit has lost some of its lustre this year after a positive start, and spreads have gapped wider in all sectors. We think that they might be due for a spell of tightening now.

QE had an impact on spread markets, but the extent to which they offered support is unquantifiable. Some 20% of the eligible market of around €700bn was sucked up by the ECB but the expected ending of it isn’t necessarily a harbinger of wider spreads. We think that the ECB will be reinvesting maturing proceeds of circa €4bn per month and so some support will continue. Aside from that, investors have been limiting long portfolio cash and will be emboldened by the press conference last week that policy rates are not going anywhere for at least another year.

If there was anything ever close to a ‘gimme trade’, the ECB effectively gave us it. Borrowers have been lining up deals aplenty judging by the rammed pipeline and those already slated to print will do as soon as. Others will bide their time. Low rates for longer and tightening spreads along with good demand mean lower funding costs than borrowers might have expected – even only last week. So we might now expect a solid end to the month for issuance with several borrowers unusually getting deals away already on Friday into some kind of euphoric moment.

Spreads will tighten in cash again although by how much might depend on the general tone for risk assets, the level of issuance from the primary market and the receptivity to those deals. Yield is what will matter again and as the European rate market looks too rich, credit must be in the ascendancy.

For example, five year Bund yields are at -0.24% (-5bp on Friday) having dipped albeit briefly into positive territory around a month ago. We would also think that higher beta sectors will recover their lure, meaning that absent the threat of a systemic crisis (Italy needs to play ball), then the AT1 market has a chance to outperform, having come under much fire in Q2.


Primary set to flourish

We had a busy primary market last Friday, which is extremely unusual in the credit market. It just goes to show how some borrowers might have been wanting to tap into the bullish tone generated by the ECB’s meeting the day before. The session had something from each sector (IG, financials, HY) and delivered €2.75bn in non-financial issuance from three borrowers (four tranches) taking us to €8.75bn of issuance for the month.

JAB Holdings kicked us off with a dual tranche €1.5bn offering, taking €750m in an 8-year at midswaps+115bp and the same amount again in an 11-year maturity at midswaps+150bp. Combined books amounted to a massive €7.2bn and allowed final pricing to be culled by 25bp for each tranche versus the initial guidance.

Next up was Autoliv with a €500m deal priced at midswaps+55bp for a 5-year maturity. The book was up at a very decent €2.8bn allowing final pricing to come 20bp inside the opening talk. The final IG non-financial deal in the session came from Engie SA which priced a 10-year offering at midswaps+50bp (-15bp versus IPT) for a €750m, off a book at just €1.25bn for a less-fancied deal.

Senior financial saw Nordea Bank take €1bn in an inaugural senior non-preferred offering at midswaps+60bp (off a €3bn book), while HSBC lifted £1bn in a 5NC4 transaction at G+135bp. In high yield, EC Finance tapped its 2.375% Nov 2022 deal for a further €150m. 

Bayer’s blockbuster deal up next? AT&T will also have a lot to do following the approval of the tie-up with Time Warner, and AT&T was downgraded to mid-triple B by Moody’s and S&P late on Friday in anticipation of a flood of issuance to come from the borrower – likely in all markets.


Trade war muddies the water

The 10-year Bund yield dropped by 4bp to 0.40% partly on the back of the ECB and some on the decision by the Trump administration to put import tariffs of 25% on $50bn of Chinese exports to the US.

US Treasuries were also better bid (10-year at 2.92%, -3bp) and we saw that flattening in the curve – 2s/10s to as low as 35bp before we closed with it at 37bp. We even saw a good recovery in Italian debt, with the 10-year yielding a relatively lowly 2.62% (-13bp).

Equities were under pressure into the end of the week, focusing on the trade war between the US and China at the moment, but one which is likely to become global unless one of the protagonists accedes to the demands of the other. The DAX lost 0.74%, the FTSE 1.7% and US markets up to 0.3%.

Few will be chasing secondary tighter, knowing full well that there is a major level of new issuance to come. But against a backdrop of weaker equities on Friday, we did manage a moderate squeeze in spreads. It left the iBoxx index at B+124.5bp (-0.7bp) as we closed the week and that was a 5bp tightening though it.

The same went for the high yield sector,  just 1.6bp tighter in last week’s final session at B+375bp, but that represented a 10bp recovery for the week. As suggested above, we hold out for more of the same for the coming weeks.

Synthetic credit had a good day on Thursday as protection costs ratcheted lower, but were more hesitant on Friday into that weakness in equities. We closed with Main close on unchanged at 65.6bp (-0.3bp) and X-Over 1.4bp higher at 293.0bp.

As for this week, primary is all that will matter for corporate bond markets and we will be looking for a whole host of issuance. That might initially weigh on spreads, but if deals are cheap, don’t massively have a repricing impact and perform on the break then we can hold firm. We going to need a broadly risk-on tone too. It’s a lot to ask!

For the rest of the week, we’re fairly light on data – with a host of manufacturing reports due from the US and Europe, and we have the rate decision from the BoE where we will expect no change given the weakening in the UK economy.

Have a good day.


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Suki Mann

A 30+ 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 CreditMarketDaily.com.