28th October 2018

Fat lady finding her voice

MARKET CLOSE:
iTraxx Main

77.6bp, +2.1bp

iTraxx X-Over

306.6bp, +6.2bp

🇩🇪 10 Yr Bund

0.35%, -5bp

iBoxx Corp IG

B+145.2bp, +2.5bp

iBoxx Corp HY

B+443bp, +10bp

🇺🇸 10 Yr US T-Bond

3.08%, -5bp

🇬🇧 FTSE 100

7356.42, -29.00
🇩🇪 DAX

12457.70, -0.10
🇺🇸 S&P 500

3006.79, +1.03

Buy the dip? Not this time…

If it feels like it, it probably is: put up those barricades. Friday was another bad day after the good recovery on Thursday. The sustainability of any rally continues to elude. And while we fret about the multitude of developing situations on the geopolitical front that are causing periods of angst, it’s simple, good old-fashioned macro that is responsible for the recent dire market performance. And it is all coming out in the earnings season, with a plethora of bellwether, geographically diverse exposed corporates missing on profits and warning on future growth.

Of course, equities are going to be looking overvalued and exposed. Credit is weaker, but secondary market illiquidity is probably containing the fallout for now. The asset class is massively outperforming.

The US economy is almost alone in bucking the trend at the moment. But we are seeing a slowdown in global growth coming from generally higher US market rates amid less accommodative central bank policies. And there is a further loss in confidence across the board as a result of the tariff trade war as corporates and individuals commit less to investment and consumption.

A 2% rise in equity markets (on Thursday last week) gave us little idea as to whether we ought to have bought the dip previously. Normally it might be the case, but such has been the volatility and unpredictability of October, fingers will have been burned.

For corporate bond market investors, there is a feeling of being stuck in a liquidity rut, which means reduced levels of turnover as the provision of already low levels of secondary market liquidity withdraws some more. Each enquiry is seeing spreads marked wider. It is difficult, for example, to sell cyclicals for anyone wishing to reduce exposures in those sectors. The Street isn’t holding inventory and there is poor bid on the other side (no buyers) as the Street seeks to rotate risk. Financials have had a tough time of it of late (AT1 risk under some pressure mostly on the back of Italy) and paper looks cheap, but it continues to cheapen.

If we are coming towards the end of the economic cycle (as is likely), then we would think there might be some looking to reduce those cyclical overweights mentioned above. But to do that efficiently, we’re going to need a few good sessions in equities, which might come off the back of a consistent stream of decent earnings and a lowering of geopolitical event risk. The hope is then that any returning confidence might result in buyers returning (tighter spreads, demand for credit) allowing for nervous (forward-looking) investors to reduce high beta overweights.

That IS too much to expect. At best we could expect a slow grind (tighter or wider) from here, where we are so close to year-end that few will be looking to do anything drastic and prefer to protect current performance. Credit markets, after all, from a total return angle have had a relatively good year and performance stacks up superbly against equities. Total return losses of up to 1% in IG (and HY) portfolios come year-end won’t be scoffed at, and will possibly be enough to keep outflows at a minimum.


Sea of heartache

The US GDP numbers for Q3 had the economy growing at an annualised rate of 3.5% which beat the 3.3% expected, but represented a slowdown from the 4.2% rate seen in Q2. It was still a solid quarter, led by consumer and government spending. There is enough in it all to keep the Fed on its tightening trajectory, but the hawkish policy might need to be much more cognisant of – and pay attention to – the heavy fall in markets. That is, financial conditions have tightened as a result of this sell-off.

It’s also looking like the ECB might have to yield on its policy tightening trajectory too, but they can afford to wait – and decide to extend QE beyond year-end.

Whatever, we finally had a good bid for Treasuries and the 10-year yield dropped to 3.08% (-5bp) while the 2-year fell 6bp to 2.81%. The bid for safety helped the Bund rally and the 10-year yield fall to 0.35% (-5bp) while Gilt yields dropped to 1.38% (-6bp) in the same maturity. There’s nothing there yet suggestive of an impending systemic crisis – that will come, as usual, when we least anticipate and suddenly.

Equities, though, are the story – and we are transfixed by them. After a quite volatile session on Friday, US stocks managed to close off their worst levels. Still, the S&P closed 1.7% and the Dow 1.2% with the Nasdaq off 2.1% having been down over 3% at one stage. The S&P has lost a stunning 9.7% so far in October and undone all and more of the previous nine months’ good work. For the year to date, it is 0.5% in the red!

It’s a lot worse for European equities. The DAX is off ‘just’ 8.6% in the month, but this total return index has fallen a massive 13.3% year to date.

In credit, of course, the cost for protection rose with some hedging going on, which left iTraxx Main higher at 77.6bp (+2.1bp) and X-Over 6.2bp higher at 306.6bp. The cash market was also wider with the iBoxx cash IG index giving up 2.5bp to B+145.2bp. High beta was feeling it a little more and we saw a little more weakness in CoCos and high yield markets, the iBoxx HY index 10bp higher at B+443bp.

The HY index has lost 1.4% this month/year (total return) so far. In IG, total returns are -0.6% (year to date) and 0% for the month to date, although spreads are 48bp and 14bp wider, respectively. There were no deals on Friday and just €2.6bn was issued last week in IG (€9.6bn for the month so far), with only Netflix’s €1.1bn issue populating the HY statistics (€4.4bn for the month). Senior and subordinated financials drew a blank.

Italy: Troubling times

At the moment it’s all brooding, serving up the perfect storm – potentially. A systemic crisis can come from a massive loss in confidence and panic in Italy. There is a stand-off between the European Commission and the sovereign and neither is backing down. The sovereign got a big boost after the close on Friday after S&P only reduced its rating outlook to negative from stable as it kept the triple-B assessment unchanged.

Otherwise, the bid for safe havens is lowering yields and maybe offering a temporary reprieve for some EM dollar funders, but the market for new deals is closed. And the Chinese Renminbi is under pressure heaping higher service costs on foreign currency debt of domestically exposed corporates. Other EM corporates are also feeling the chill.

Right now, most will be happy to see the month out without too many further losses. Just three sessions to go! For the week ahead, it’s the Brazilian elections, US non-farm payrolls and 140 S&P companies like Kraft, GE and Mondelez reporting earnings.

Have a good day.


For the latest on corporate bonds from financial news sources, click here.

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.

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