8th September 2019

To the ECB, the market expects

MARKET CLOSE:
iTraxx Main

47.1bp, -1bp

iTraxx X-Over

238.5bp, -6.6bp

🇩🇪 10 Yr Bund

-0.64%, -4bp

iBoxx Corp IG

B+123.3bp, +1bp

iBoxx Corp HY

B+417bp, +4bp

🇺🇸 10 Yr US T-Bond

1.56%, unchanged

🇬🇧 FTSE 100

7324.17, (-0.80%)
🇩🇪 DAX

13253.75, (-0.38%)
🇺🇸 S&P 500

3096.63, (-0.05%)

Time for Draghi to step up – Again…

The markets are going to be focused on the ECB this week. Investors have been front-running them for so long, and with Draghi taking his bow in several weeks, we think that the central bank will finally take action – Whatever the protestations of some board members. The market expects.

Even if the political news flow has been better of late (Brexit, Italy, Hong Kong, US/China) and boosted the market, the macro numbers remain dire across the Eurozone. The latest numbers saw industrial production drop 0.6% month-on-month in Germany in July, where the odds are in favour of a technical recession being called come the end of Q3. Now is not the time for the ECB to delay and dither further.

We’re thinking in terms of a 20bp rate cut and a resumption of quantitative easing (with a likely compromise €15bn of purchases per month). It will be a shot in the arm that keeps the zombified Eurozone economy ticking along. But it will be a major boost for those fixed income investors hoping that rates can rally some more and the current performance can be maintained. As for 2020’s returns, it is just too far away to start thinking about!

With that easing in mind, we’re going to see primary remain buoyant. We have had a quite fantastic opening week of the month (€19bn issued, IG non-financals) and is on target for a perhaps as much as €40bn. Certainly the current run rate suggests as much, which would then likely see the full year IG non-financial issuance come in at a fresh record level (which is €285bn).

We’re currently up at €221bn for the year to date, and exceed the total for the whole of 2018 already (which, admittedly, came in low at €220bn). We are on course to end the month somewhere in the region of €240bn, all things being equal.

It’s no coincidence that the record year for supply was 2009 – the year after the financial crisis when rates were being slashed, corporates were getting as much liquidity on board as possible and funding costs were dropping precipitously, having previously ramped higher in the immediate aftermath of the financial crisis.

We have a similar situation now as far as rates directionality is concerned. Cash-rich corporates are more likely in the market now in order to prefund maturing obligations (whenever they might be due) given the extremely low borrowing costs, rather than for reasons of investment or shoring up balance sheets.


Reverse Yankee issuance at record levels

Schlumberger’s issue on Friday added another €1.5bn to the total for US borrowers in the markets in euros this year, and took the total for the year to date to almost €72bn – or a third of the market. German and French borrowers represent around 19% each, while UK domiciled entities account for 7.4% of the IG non-financial borrowers (see chart below).  Every one of those US deals can be seen in detail here.

The focus is on the €72bn. The figure represents a record level of issuance from US-domiciled borrowers, in Europe looking for a cheaper and diversified funding stream from the welcoming euro-denominated debt markets. The previous record Reverse Yankee issuance high was €69bn in 2015.

US Corporate Borrowers as a % of Total Euro IG Issuance

There is more to come, and we are on course to hit that €100bn total for the year. If funding costs take another leg lower on any ECB action (likely to be announced this week) then there will be plenty of incentive for more Reverse Yankee borrowing.


Macro weakness points to policy accommodation

The massive pullback in rates markets on Tuesday was only partially reversed on Friday. Don’t worry – give it time, yields are heading lower. In the UK, though, it was a near total reversal, likely due to apprehension about Boris Johnson’s next move. The 10-year Gilt yield put on 12bp during Thursday’s hectic session, but gave up 9bp on Friday to close out the week yielding 0.50%.

The magnitude of the move was less elsewhere, but followed the same direction with the 10-year Bund yield down at -0.64% (-4bp), the BTP at 0.87% (-4bp) and the Bono yield at just 0.17% (-7bp).

The non-farm payroll report for August saw the US add 130,000 jobs, but that was less than the 158,000 expected. Employment growth slowed and there were revisions downward revisions to job growth for the previous two months. The market will be pricing in a 25bp rate cut in a couple of weeks time. China had already added its own stimulus through the easing of bank lending criteria as it sought to stem weakness rippling though its economy.

The US Treasury yield was unchanged though, at 1.56%. Equity markets were trading flattish in a dull session for them in the US, although we did have some big moves higher the day before.

In credit, as already highlighted, Schlumberger issued €1.5bn split equally between three tranches. A long 5-year came at midswaps+50bp, the long 8-year at midswaps+60bp and a 12-year maturity printed at midswaps+70bp. They were all priced 15bp inside the initial guidance and combined books came in at €3.7bn.

Away from that, iTraxx Main closed a basis point lower at 47.1bp and X-Over moved 6.6bp lower to 238.5bp. The cash market was quiet but slightly better offered for choice, leaving the iBoxx IG index at 123.3bp (+1bp) and the high yield index at B+417bp (+4bp).

As for this week, we have what promises to be a monuments day for British politics to kick us off as we conclude the current session of Parliament with a possible vote on an election (Tories expected to be denied it).

On Thursday, the market will be firmly focused on the ECB and those policy (more stimulus) announcements. In between, we have US CPI, retail sales and consumer sentiment data.

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.