2nd Nov 2016

Federal Reserve in the spotlight again

MARKET CLOSE:
FTSE 100
6,917, -37
DAX
10,526, -139
S&P 500
2,111, -14
iTraxx Main
74.75bp, +1.5bp
iTraxx X-Over Index
335bp, +5bp
10 Yr Bund
0.18%, +1.5bp
iBoxx Corp IG
B+122.8bp, +1.5bp 
iBoxx Corp HY Index
B+411.5bp, +2bp
10 Yr US T-Bond
1.83%, unchanged

Rate markets dominate…

The All Saints Day break gave us a chance to sit back and take a look as to how it “all” stands. It hasn’t been the best of Octobers (they usually aren’t), and it’s the rate markets that are causing the most consternation amongst (especially) fixed income investors. The Bund yield saw +0.20% in yesterday’s session and our call that is would see -0.20% before that has proved to have been too bearish (on inflation expectations).

Well, we have a bit of inflation in the Eurozone, but it is stuck at very low levels with the trajectory of it still uncertain and the 2% policy target rate is still way off. GDP growth is also stuck at low levels. But for some reason, the market thinks a Fed rate hike (in December) is a harbinger of things to come on this side of the pond – in terms of imminent ECB tapering of asset purchases, and eventually decent or more normal levels of economic activity.

We don’t think it is. We’re not six months behind the US in terms of growth and policy – as conventional thinking and historical precedence would have markets believe. Such has been the massive distorting effect of monetary policy (QE and the like), that if we come out of this crisis following the US in growth terms by six months or so, then it would be a fantastic result. And relief.

However, fixed income markets will need to brace for a soul-destroying (rather performance battering) 2017. We’re hanging in there for 2016 with some still very good returns, all things considered, but there is a non-trivial probability of it all going awry if rate markets so wish.

Overall, the session was dominated by the upcoming Fed shindig with markets fretting that they might even do something in today’s meeting. It’s par for the course these days. So, the 10-year Bund yield ended the session at 0.17% (+1bp) and the equivalent Gilt yield was 3.5bp higher at 1.28% (+60bp off the lows in a flash).

Brexit fears have turned to hope and elation for global economics as evidenced by the moves seen in duration risk over the last month. Peripheral yields took a pounding, with Italian BTPs yielding 1.75% (+9bp) and the Bono 1.30% (+10bp) – some 75bp and 40bp off the record lows, respectively.

Those record lows were seen several weeks ago and it is strange not to be talking in terms of them anymore. It’s like we will need a catastrophe to strike for us to get down to those levels again. It also suggests that the inflexion point has been passed.

The rest sidelined and nervous as well

So we kicked off the opening session of the month with little happening owing to that break, but in light markets there was obviously a defensive feel to positions. Bund yields came off earlier highs, equities did very little initially but sold off into the afternoon, primary credit was effectively closed and the secondary markets stayed sidelined too. The Fed is looming and it was always going to be bit of a “nothing day” while we await their decision. The DAX was off almost 1.5% and most other markets 1% or more.

It’s not as if the US recovery is assured anyway. Manufacturing expanded last month – pretty much chugging along, while Chrysler reported a 10% year-on-year decline in sales. It would appear that the markets were hanging their hat on the official Chinese PMI data which showed manufacturing improved at the fastest rate for a couple of years.

If recovery is in sight, the credit to equity rotation trade isn’t going to be too far behind. We will see out this year and the first quarter of next easily enough with good support for spread markets while the ECB is running its proverbial vacuum cleaner over the corporate bond sector. But tapering will come with evidence of sustainable recovery and that means equities will win out over corporate risk.

We will get a better picture of that in December following the final ECB meeting of the year. For now, we hadn’t ought to concern ourselves too much, and should underlying yields remain supportive, we will have clipped 5%+ in IG credit and 7%+ in HY credit this year; 10% for sterling corporate bonds might still happen, too.

Standard Chartered stumps market

The economics of the call around the 2006 issued 6.409% Tier 1 Standard Chartered bond saw to it that the bank decided not to call the issue. Outside of crisis dynamics, it’s rare we get one of these situations, but such is the level of the market at the moment for deeply subordinated debt, it “made sense” for the bank not to call. Prices plummeted (by up to 15 points).

And of course, the market will forgive and likely choose to forget much like it did eventually when Deutsche Bank did the same a few years back on a LT2 deal. We assume Standard Chartered have no immediate funding plans though!

Generally, we saw a little weakness overall, but nothing to concern us. The Markit iBoxx index closed a little higher (month end revaluations included) but we’re still at B+123bp for the index. Credit is holding up very well. Spreads on the sterling index went the other way – tighter, but they were mostly due to index moves.

Overall, the sterling corporate bond market closed out pretty much unchanged. The drab session extended to the high yield market where spreads also edged out a touch leaving the cash index 2bp wider and most of that coming from index changes over the month end. The iTraxx indices closed with Main up at 74.75bp and X-Over at 335bp.

That’s it. Back in the morning.

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.