1st February 2018

Hot under the collar

MARKET CLOSE:
iTraxx Main

43.9bp, +0.2bp

iTraxx X-Over

240.4bp, +2.3bp

10 Yr Bund

0.73%, +1.5bp

iBoxx Corp IG

B+82.7bp, -0.5bp

iBoxx Corp HY

B+273.3bp, +4bp

10 Yr US T-Bond

2.79%, +7bp

FTSE 100 , DAX , S&P 500 ,

But credit still holding its ground…

We might have ended January’s final few sessions with some trepidation, and we have started February with more of the same. Currency strength is impacting equities and solid economic growth dynamics have rate markets flustered. Admittedly, the corporate bond market is yet to feel any heat and displays little or none of the volatility that has hit equities of late, nor any of the weakness ripping through the rate markets.

Most had previously laid out a path for 2018 that saw macro in a firmer recovery mode – meaning higher equities, modestly higher government bond yields and a small tightening in corporate bond spreads. Good or bad, year-end target for some of these credit markets are close to already being met!

The macro side of things look very good at the moment and we think growth rate for the full year are going to be revised higher. We had Eurozone manufacturing PMIs for January in the session, suggesting that side of the economy is in full bloom even if Germany missed estimates by the smallest amount. Job creation, investment, expansion in capacity and so on are all aligned and the outlook for the region appears very upbeat.

With inflation still contained, it’s baby steps as far as the ECB is concerned. So, policy stays accommodative which means higher equities most likely, with the big impediment to growth, profits and the eventual level of the equity markets being the strength of the euro.

Rates? Our view, set out several weeks ago, was for the benchmark 10-year Bund yield to rise to 0.75% by the end of 2018, whereas now it will likely reside in the 0.70 – 0.90% region come year-end. They’re already up at the bottom end of the aforementioned range (+25bp in January), we think dragged higher because the US Treasury market is feeling a little hot under the collar too (+42bp this year, on the US 10-year yield). We would think that once we have settled into a new mindset, where we know that the economic growth rate is increasing, that we have some semblance of a more normal economic cycle free from the meddling manipulative central bank policies, then rate markets will stabilise and move (higher) more according to policy.

For credit, the near 14bp of tightening in IG Markit iBoxx index has already almost covered all the tightening we expected (-16bp). We’re less than 3bp short of our B+80bp year-end target and at the current rate, we will likely be there come next week. Remember, these are record tight levels, It also a massive monthly tightening. Into an economic upswing and with the tone so upbeat, we must be looking at a sub-70bp like context for IG spreads on this index.

HY secondary has tightened too, but it hasn’t quite stirred the cockles in the same way.Spreads have tightened by 13bp to B+273bp, but are still 33bp off the target we set for the full-year, while they’re 19bp away from the record index level. There is a reluctance by investors to chase this market tighter.

That chase, though, is for subordinated bank risk and the outperformer in this category of asset class is the contingent convertible market. We’ve had a couple of issues this year already, and are likely going to see €25-30bn of supply in 2018. But, the demand for higher yielding banking sector risk – as its credit fundamentals improve – is going to see further compression between these products’ spreads and all other low beta corporate bond assets.

The CoCo index, for example, is over 60bp tighter already in January and we ought to be looking for that to be repeated over the next 6 months (the rate of tightening must slow).


Corporate primary perks up

Prosegur Prosegur Cia de Seguridad: €700m

Following a relative lull in IG issuance of late, we had several borrowers in the market on the opening day of the month. The day’s five issues from three borrowers served up €2.95bn and took the total for the opening weeks of the year to over €20bn (actually €21.1bn).

So, for IG non-financials, Ford Motor Credit came up with a couple of deals, issuing €750m in a 4-year floater format, alongside a €500m fixed issue in a 7-year maturity priced at Euribor+42bp and midswaps+60bp, respectively. They were 18bp and 10bp tighter than the initial guidance, respectively.

Acea was up next and also with a dual tranche taking €300m in a 5-year floater at Euribor+37bp (-13bp versus IPT) and €700m in a long 9-year at midswaps+70bp which was 10bp tighter than the initial mumble.

Combined books for the €1bn total offering was around €2.5bn. Spanish security group Prosegur Cia de Seguridad visited for €700m in a 5-year offering at midswaps+62bp and managed to garner a book of €3.25bn allowing them to reduce the final cost of funding by 23bp versus the opening guidance.

In financials, it was Banco Santander with a €1.25bn 10-year Tier 2 issue priced at midswaps+110bp versus the midswaps+125bp initial guidance level, on books at over €2.5bn.

UK-based retirement specialist group, Just Group PLC issued £230m in a 7-year subordinated Tier 3 deal priced at Gilts+225bp (-37.5bp versus IPT) and Romania was the day’s sovereign borrower as it issued in 12-year and 20-year maturities for a combined €2bn.


Currency strength weighs on European stocks

As suggested earlier in this note, the strengthening euro has started to have an impact on stocks. The Dax took it right on the chin, falling as much as 1.6% intraday, before recovering a touch to close 1.4% lower as European stocks all stayed in the red for the session. In the US, we had a mixed bag of earnings (UPS, US auto sales, Ralph Lauren, Mastercard and Time Warner to name but a few) and stocks there were mostly flattish in the session before bit of a recovery saw them move smartly higher (up to 0.5%) – and then flattish again!

The rate markets didn’t manage to recover anything in a day which saw yields play out in tight ranges for the most part. The UK 10 year Gilt yield was up at 1.53% (+2bp), the equivalent maturity Bund at 0.73% (+1.5bp) while the 10 year benchmark US Treasury was underperforming big time and the yield rose to a stunning 2.79% (+7bp) – with the 30-year back past 3% (at 3.03%, +8.5bp).

The iTraxx indices took their direction from the tone in European equities, and so the cost of protection rose as better buyers emerged. iTraxx Main closed just a touch higher at 43.9bp (+0.2bp) while X-Over gave up 2.3bp to close at 240.4bp.

In cash, the focus was on primary as we would naturally expect. However, the secondary market outperformed synthetics again, and edged 0.5bp tighter (IG iBoxx) to a new record tight of B+82.7bp. In the high yield secondary market, the session played out as we might have expected. Little activity, no fresh issuance and spreads marked a touch wider, the iBoxx index at B+273.3bp (+4bp).

Have a good day.


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

Suki Mann

A 30+ 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 CreditMarketDaily.com.