12th September 2019

Draghi: No happy ending

iTraxx Main

45.0bp, -4.6bp

iTraxx X-Over

235.5bp, -13.4bp

🇩🇪 10 Yr Bund

-0.51%, +5bp

iBoxx Corp IG

B+122bp, -4bp

iBoxx Corp HY

B+402bp, -14bp

🇺🇸 10 Yr US T-Bond

1.77%, +4bp

🇬🇧 FTSE 100

7409.13, (-0.58%)
🇩🇪 DAX

13744.21, (-0.01%)
🇺🇸 S&P 500

3380.16, (+0.18%)

HY/IG compression: Shades of 2016…

The President of the central bank might have been a little schackled, but Draghi largely likely got his way in finding some middle ground, enabling him to keep the doves and hawks both content. A compromise 10bp cut on the deposit facility to -0.50% – as well as a tiering system for banks’ holding of excess liquidity – and €20bn of QE from November is good enough. The open-ended nature of the purchases is going to boost that hunt for yield. Hold on tight.

The markets might be a touch disappointed that it wasn’t 20bp and €30bn, respectively, but the ECB did the very least we could have reasonably expected. Fixed income markets are not going to fall out of bed on this news. Thus a reasonable interpretation from seasoned investors on the day’s events will be that there is more to come in 2020. In fact, there is an inevitability about it all.

Flagging: Germany

After all, inflation is showing no signs of picking up, Germany is in recession (the reported fall in July’s industrial output during the session was dire) and the rest of the Eurozone isn’t far behind. There is a protracted slowdown across the region and global growth is slowing. Even if there is some thawing in US/Chinese trade tensions, it is coming too late to stave off a serious dent in global macro over the next 6-9 months.

The good (?) news is that we are unlikely going to see a material collapse in current economic conditions. Funding conditions are going to ease across the board. That 10-year bund yield will be down at -1.0% in Q4 2019, we would think, although we might have to wait until the early part of 2020. But it’s coming.

Into the initial euphoria, the grab for yield saw the 10-year BTP yield down at a record low of 0.77% (-121bp) intraday – for a country with a fragile coalition government, the highest levels of indebtedness across the Eurozone and a busted economy. We’ll forgive them for it, given the higher yields BTPs offer, while Spain will be next to fall into negative yield territory for its 10-year Bonos. The rally faded into the close, but the signs are ominous.

In credit, we can expect a slew of deals through to year-end and we should be looking at a record year for IG non-financial issuance which currently stands at €230bn. €285bn is the full-year record. Q1/2020 might also come in at higher-than-average levels as borrowers look to refund maturing obligations. They won’t be funding for anything much other than that. The macro outlook is too uncertain for greater levels of investment, for example.

Just as we are witnessing that high level compression in the government bond markets, we are going to see it in credit too. We’ve been suggesting that it was coming for a while now. The high yield market ought to see spreads/yield crunch tighter/lower. There will be a renewed crowding-out impacting IG investors who will find their way into the HY markets.

Lower funding costs will keep the default rate at low and manageable/bearable levels – even as the economy plods along at lower growth rates for longer. That’s a function purely of manipulated markets. In most cases, it will help justify a greater allocation towards the asset class just as it did previously. It might feel like 2016/17 all over again.

Mixed, choppy, rallies fade: But credit’s compression starts

We didn’t quite follow through the early promise, in a day of weak economic news, dovish policy announcements and some hope on the US/China trade war. It will all come out in the wash in due course.

Gold almost had a super day, up 1.5% on the news to $1,525 per ounce, before dropping back $1,508 (+$6). The euro was understandably weaker against the dollar and sterling after the ECB announcements but again managed to recover most, if not all, of its losses. Equities only managed moderate gains (Dax +0.4%, S&P +0.5% as at the time of writing). The action once again was in rate markets.

The initial rate market euphoria subsided soon enough, however. And relatively spectacularly. Everything in the safe-haven sector went back to flat and then we went into sell-off territory. Bunds were yielding -0.51% (+1bp, and a 13bp swing in the session), Gilts 0.67% (+3bp) and US Treasuries 1.77% (+4bp). However, BTPs in the 10-year closed yielding 0.84% (-12bp) and Bonos 0.21% (-4bp).

Credit alone rallied, and hard. In synthetics, iTraxx Main closed 4.6bp lower at 45bp and X-Over was 13.4bp lower at 235.5bp.

Cash followed suit with the IG iBoxx cash index 4bp tighter at B+122bp and reversed a week of widening. Rates have sold off and the index yield has too, now up at 0.54%, representing a 16bp reversal off the record low seen less than 2 weeks ago.

High Yield – IG Yield Recent History:

The help afforded to bank deposits by the ECB added some juice to the banking sector. Mind, it was predominately a case of trying to get hold of higher-yielding assets – helping the AT1 market rally 27bp for the iBoxx index, which is now tighter at B+491bp. Returns are shooting higher, now at 12.4% for the year to date!

In high yield, the same. The sector’s spreads crunched tighter, with the index left at B+402bp – some 14bp tighter in the session. Total returns rose to their highest level year to date, to 9.2%.

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.