15th November 2016

Fixed income markets flogged

FTSE 100
6,753, +23
10,693, +26
S&P 500
2,164, unchanged
iTraxx Main
79bp, +0.5bp
iTraxx X-Over Index
351bp, unchanged
10 Yr Bund
0.32%, +1bp
iBoxx Corp IG
B+129.4bp, +2.7bp 
iBoxx Corp HY Index
B+434bp, +10bp
10 Yr US T-Bond
2.24%, +9bp

Throwing in the towel…

The Donald's strategy is bad news for bonds

The Donald’s current strategy is bad news for bonds

Well, it’s a rout. Bond market woes see no end. Duration is getting crushed and there is little we’re going to be able to do about it. The fear of that massive governmental spending spree in the US has now hammered performance for the 2016 for fixed income markets. We’re calling it – and would pay up to anyone who wagered on this eventuality – early.

It is going to take an about-turn by President-elect Trump in one of his interviews suggesting that the pace in the increase of spending will be moderate for it to save us. He won’t do that because it is the easiest of his pre-election pledges to keep. And in a way, it was “event-risk” few would have positioned for given the overriding view that all and sundry thought he would lose the election. Well, fixed income markets are now the losers.

At around the worst levels for the session, the bellwether 10-year Bund yield backed-up 0.38% (+7.5bp), while the equivalent-maturity Gilt rose 11bp to 1.47% and the 30-year some 12bp to 2.14%. Italian government bonds got a thrashing as the yield on them rose to 2.19% (+18bp) with 10-year Spanish Bonos at 1.63% (+16bp). Worse, the performance YTD is now what you would expect from a so-called “safe-haven” product – after some tremendous performance to end October. Returns for Eurozone government bonds are now at +1.4% YTD, having resided at over 4% in the year to the end of October – just as yields were beginning their ascent. Frustrating.

For the big picture, the bond sell-off is not going to help policymakers in Europe hoping for the low yields that have come from accommodative monetary policy to oil the machinery of the Eurozone’s economy. Current policy will have seen to have failed (it already has, some would suggest), if yields go higher while we have this massive QE going on and the economy returns to an even weaker trajectory.

September’s industrial production across the Eurozone disappointed as it fell 0.8% month-on-month, for example. With the macro outlook now uncertain as ever, investment, capex and other decisions are bound to stall. Around Brexit those decisions were very UK-centric, while with the US the impact will be felt more globally given the importance and reach of that economy.

If “Trumponomics” is the way forward and other governments follow suit – namely tit-for-tat protectionist moves and fiscal laxity – then sovereign credit implications will reach far and wide. Trade flows might well hammer EM (FX, bonds and equities) while any loosening of the fiscal purse strings in the Eurozone (in a copycat populist move) will see ratings pressure on already highly indebted government where the cost of borrowing is already increasing! Who said growth was “always” good? Not us.

The next ECB meeting will be interesting. Taper? No way!

Corporate risk aversion gathering pace

Corporate bond spreads are feeling a little hot under the collar, unable to break-away from the weakness besetting government bonds. The link between the two is about performance for total return players whose participation has grown exponentially over the last few years through the low-yielding, heightened risk averse environment we have traded through. However, fundamentals overall remain sound, the ability to service debt still the best it has ever been, balance sheet posture supportive for ratings and the default rate are low. All that will stay as is.

The big change now is going to be rising debt costs for corporates (although we believe that will not be too difficult an issue to bear given we are coming off extraordinary low levels anyway) and for investors – the worry about flows. More specifically, the potential for outflows.

The big moves in government bond yields might not have filtered through into the corporate bond market yet in quite the same way as seen in the cash index moves, but filter down and we are beginning to see some decent moves wider (in spread) and lower in cash on individual entities in EM and peripheral credit. Risk aversion is gathering pace. To see it more clearly, those heightened nerves are being noticed by the moves higher in the cost of protection. This market has been better bid since the election and some meaty moves have resulted from it. Main, for example, is now at 79bp and X-Over at 351bp – both unchanged in the day – but the highest levels for a good while.

Good news? ECB continues to suck up corporate debt

After €2.54bn two weeks ago, the ECB’s pace of corporate bond purchases dropped to the long-term average to €1.8bn (see chart, below).

The central bank has now amassed €42.2bn of IG non-financial debt – and taken it permanently out of the market – since the asset purchase programme began some 23 weeks ago. Some might be tempted to look at the lower figure of €1.8bn last week – €700m down versus the prior one – and think that the slowdown is also a result of the impact of the general risk aversion elsewhere. It isn’t – the ECB doesn’t care – it is too early to draw any conclusions. After all, last week’s purchases have only dropped to the long-term average level.

Recent ECB weekly bond purchases

Elsewhere in the market, we had AbbVie finally launch its bond offering as it took €3.6bn on 3, 7 and 12-year funding and they still managed to tighten the deal up by between 10-20bp versus initial indications. We’re not sure that kind of tightening is going to hold and will depend on sentiment as investors grapple with the rising yield environment. That was the only deal in the session, but we have many announcement and expect a swathe of supply to hit the screens this week in both the IG and HY markets.

The AbbVie deal took us past €10bn for the month in issuance (to €11bn) and should markets not fall out of bed from these levels, €20-25bn before the month is out would be a reasonable expectation for non-financial IG issuance.

Enough is enough.. but we will go on

He’s had just one trip to the White House that we are aware of, and we’re hoping for no more for the moment. The seat there hasn’t yet been vacated, but we’re grappling with trying to stem the sell-off. We closed out with the markets off their worst levels for the session. The 10-year Bund yield was at 0.32% (+2bp), the Gilt was yielding 1.40% (+4bp), BTPs 2.08% (just +6.5bp) and Bonos were left yielding 1.51% (+4bp). The 10-year Treasury was yielding 2.24% (+9bp) while the 2-year just pulled back from 1% and the 2s/10s spread was up at 125bp.

European equities played out in positive territory with most bourses up by around 0.25% amid obvious nervousness as markets try to figure out how to position for an uncertain 2017.

In credit, that €1.8bn weekly ECB hoard failed to stem the slide wider in spreads. Macro is dominating everywhere. The Markit iBoxx IG index was higher at B+129.4bp (+2.7bp) and returns are at 3.9% YTD. Sterling IG spreads held up better, the index here just 1.25bp wider at G+154.7bp (smaller market, more illiquid, BoE QE all helping) – but returns are dropping precipitously, now at 8.5% YTD as Gilts get beaten up – and they have halved from the peaks seen in the summer.

The high yield market wasn’t spared, with spreads wider leaving the Markit iBoxx index at B+434bp (+10bp) and likely a result of equities not working their magic into the potential for a higher growth theme. Returns came under some pressure even as the front-end of the underlying curve held firm, falling to 6.5% YTD.

Enough said. 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.