7th November 2016

Which one, stupid?

MARKET CLOSE:
FTSE 100
6,693, -97
DAX
10,259, -67
S&P 500
2,085, -3
iTraxx Main
76bp, +1bp
iTraxx X-Over Index
339bp, +4bp
10 Yr Bund
0.13%, -2bp
iBoxx Corp IG
B+125bp, +1bp 
iBoxx Corp HY Index
B+424bp, +4.5bp
10 Yr US T-Bond
1.78%, -3.5bp

The election or the economy…

usflagpolePayrolls are in good form with wage growth accelerating to full-employment target levels – leaving a December US rate hike as a nailed on certainty.

An action-packed week it was, and while we had some uncertainty (more?) around Brexit, the bigger picture suggestion is that we have seemingly passed that growth-related inflexion point. That is, the economy is on the up, be it the US, Eurozone or UK – actually global, given the latest Chinese PMIs.

We’re seemingly in good shape – albeit trying to emerge from a low level where the barrier to succeed on gaining a more respectable level of growth isn’t overly challenging or had not ought to be. But that is not really the story for this week. Nope. The US election is.

Should we be afraid of the dual pronged competing attack on the thinking, on the possible differing pulls on market direction? Trump wins and so it goes that we live in an era of great uncertainty. A political virgin in all aspects will be in charge and the markets will have us believe a dash for safe-havens will be the way forward.

Rates to stay, bonds to rally

As we suggested last week, rates will likely stay anchored, Treasury and Eurozone government bond yields will immediately rally, equities drop while corporate spreads might feel moderate heat (depending on the rate/level of the drop in stocks, but returns for find income investors will rocket (again). Clinton wins, and it will be relief all round. Higher stocks, tighter spreads, high underlying yields and reduced macro/market volatility.

The election aside, it is all about the economy. The US is chugging along, the data emerging of late from the Eurozone suggests we’re off the bottom and trying to zoom past first base (looking for higher levels of sustainable growth and inflation) while the Chinese PMIs gave hope to stability there following good industrial activity data last week. The UK economy is almost gushing post-Brexit vote, with inflation set to overshoot and growth forecast to come in the top quartile globally next year. This is just what we all wanted. Isn’t it?

If we go with the “data” as it stands, then Clinton wins and the economy is starting to recover. There will be winners and losers in it – but the future is bright, it will have us believe. Equities look set to rally (relief-related initially), policy rates will go higher only in measured from so as to not derail the recovery, yields pop sharply higher and corporate spreads tighten into the better tone. Fixed income returns decline. For corporate bond investors, we fear momentum. Momentum in economic growth, higher yields and higher stocks. And ultimately, the potential multi-year performance destroying credit to equity rotation trade. We’re not calling it just yet, though.

Primary opens with a flourish

The opening week of the month had primary in almost full flow, but that isn’t likely going to be the case this week into those election jitters. Some €6bn of IG non-financial debt was issued last week from the likes of BASF, Statoil, Dover Corp and RCI Banque. The high yield market saw three borrowers print €2bn in what again was a good week volume-wise.

This month is going to see extended periods that will likely result in little or no issuance although some might seek to cram deals in when the window is open between the US election result (if Clinton wins) and Thanksgiving. €20bn of IG issuance would be a good level of supply for this month, while €6bn+ in high yield is not impossible given the known pipeline.

Secondary markets braced come what may

The FTSE is at 6700

Below 6700: The FTSE 100 had its worst week since January on the back of US election uncertainty

There was weakness in secondary markets last week, but it was very moderate in comparison to the larger falls seen in stocks and the volatility in government bonds. We’re in a different space still versus the aforementioned two, but despite ECB/BoE QE helping to support valuations, credit spreads are not going tighter, come what may.

IG credit edged 2bp wider last week, to B+125bp (Markit iBoxx index) and was pretty much unchanged in the most lacklustre of session on Friday. Sterling corporate bonds are being very well supported by the BoE’s QE effort which is clear when set against the weakness in Gilts and equities of late. The FTSE is back below 6,700 having been above 7,000 not too long ago, for example.

Anyway, the rally in Gilts at the end of last week saw to it that returns for investors sat a little improved, popping over 11% again, having been at 10.2% YTD as we closed out October. In HY, we saw some weakness again on Friday, but the index closed at B+424bp or +12bp in the week.

This sector of the credit market does seem again to be correlated with equities and with the DAX for example almost 500 points off the recent highs from a week ago, valuations were bound to be impacted.

That doesn’t mean a lack of interest in the HY market as evidenced by the consistent and quite decent levels of activity on the primary market.

We have the ECB’s latest corporate bond shopping list later today and those US elections tomorrow. It hadn’t ought to be too busy. Have a good week, and we will be back tomorrow.

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.