29th November 2016

Elephant in the room

FTSE 100
6,799, -41
10,583, -117
S&P 500
2,202, -12
iTraxx Main
82bp, +1bp
iTraxx X-Over Index
342bp, +1bp
10 Yr Bund
0.20%, -3bp
iBoxx Corp IG
B+141bp, +1bp 
iBoxx Corp HY Index
B+451bp, +4bp
10 Yr US T-Bond
2.32%, -4bp

Duration back in vogue…

No joke: Comedian Beppe Grillo for Italy’s next PM?

When political risk is on the up and there is the potential for a follow-through causing financial instability, we usually see that equities take a hit and government bonds assume a safe-haven bid – as do non-financial IG rated corporates. Well, it all played out classically in yesterday’s session. Italian elections and the ramifications of a “No” vote next weekend – seen as a vote on Renzi (and the establishment) – are making the markets a little jumpy.

The Far Right in Austria could also see a notable gain at the weekend too. The ECB will have its work cut out. Investors, though, will be sitting a little more comfortably as duration rallied, leaving the 10-year Bund yield at 0.20% and the 2-year at a new record low in the session at -0.78%. Returns will have picked up – and very timely at that – given we’re now just two sessions away from month-end and those November performance marks.

The government bond market rally on those election fears overshadowed a rather upbeat OECD report on the global economy. Trump’s potential economic policies came out tops and the agency expects them to boost the global economy in 2017/18. Well, at least stop the world from a lower growth trajectory than might otherwise have been. Globally, they look for 2.9% of growth this year to be 3.3% in 2017 and 3.6% in 2018 while the US’ growth of 1.5% this year should be 2.3% and 3% in 2017/18, respectively. The Eurozone is expected to grow at 1.6-1.7% in 2016-2018. Fiscal policy/potential is key and that’s where the President-elect’s high-fiving is embraced while German policy gets a thumbs down.

The backlog of deals continued to grow with more mandates announced. The actual flow in IG saw €625m from Gas Networks Ireland (2-tranches) while the darlings of the German market HeidelbergCement and Continental AG took €1.6bn between them. Such was the demand, pricing was ratcheted tighter by 23bp and 18bp, respectively, versus the initial price talk. These are big pricing moves and highlight the demand from the German domestic investor base (and others) for solid, well-known names.

The deals take the monthly total for IG non-financial issuance to €24.2bn which is at the upper range of our expectations when we started the month. We do believe that the week will see up to another €5bn given the backlog and maybe a few looking to get funding in ahead of those weekend elections. We also believe that the markets will be open for business albeit if volatility stays low until around the second week of December.

ECB bond buying continues apace, but doesn’t help

But to what end? As we suggested last week, the central bank might be lifting an average in excess €1.8bn of corporate debt per week, but they have still failed to stem the current weakness in spreads. Investors are still running scared in secondary at the moment, and spreads have widened some 17bp on an index basis (Markit iBoxx) this month amid some heavy(ish) outflows from corporate bond funds. The ECB does not seem to be lifting enough bonds to help keep valuations in check. Furthermore, we also now believe that the ECB’s interest on the corporate bond market has failed to elicit a material – or measurable – increase in issuance (see above). No supply records have been broken this year.

ECB’s latest weekly purchases

As seen from the chart above, the ECB’s purchases last week totalled €1.9bn versus €2.1bn the week before. Their total purchases are now up at €46.23bn – or, put another way, a good two months worth of gross IG issuance. The one upside perhaps is that the €46bn of purchases had helped spreads tighten by a good amount (initially), and now are probably preventing them from widening more aggressively.

Funny old day

The DAX closed 1% lower and 150 points from being flat for the year. Most other bourses were 0.6% or lower. That risk off saw safe havens better bid and even Italian government debt closed out a little better. Ten-year maturity BTPs were left yielding 2.06% (-2bp) while at the other end of the scale (?) Gilts in 10-years saw yields lower at 1.38% (-4bp).

It seems like the stemming of weakness in corporate bond spreads is about the best we can expect from the ECB’s QE effort. The iBoxx Markit index shows that weakness is continuing across the board – after it was marked another basis point wider in yesterday’s session (B+141bp) and is now only 13bp tighter this year. That’s 23bp off the lows. Returns might be up – government bonds have rallied, after all, but there has to be an element of concern around valuations. Our view is that we still like corporate debt, that the moves are technical but that the current weakness might persist – given the macro outlook.

The high yield market also edged weaker although flows were light and sentiment not helped in this higher beta sector due to equity weakness. We had no primary activity but we know that the pipeline is rammed and we would think that deals will get away nevertheless. And sterling! This market outperformed. Spreads moved just a tad wider (-0.5bp) on a cash index basis. Small, illiquid, no sellers, some supply (finally with Severn Trent’s £400m deal) and ongoing QE. Can’t be bad.

The iTraxx indices closed better bid (higher) in line with weakness in line with weaker stocks, with Main at 82bp and X-Over at 342bp.

Have a good day, 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.