1st August 2019

Fixed income party still in full swing

MARKET CLOSE:
iTraxx Main

50.5bp, +0.6bp

iTraxx X-Over

252.9bp, +0.7bp

🇩🇪 10 Yr Bund

-0.45%, -3bp

iBoxx Corp IG

B+112bp, +2bp

iBoxx Corp HY

B+422bp, +12bp

🇺🇸 10 Yr US T-Bond

1.90%, -12bp

🇬🇧 FTSE 100

7324.17, (+0.14%)
🇩🇪 DAX

13253.75, (+0.47%)
🇺🇸 S&P 500

3096.63, (+0.55%)

Oh my, oh my…

Yet another great month has passed us by, giving us (so far) the unlikeliest of positive years that we have ever seen for risk markets. IG credit (iBoxx index) has returned over 1% again in July and 7% in the period from January to the end of July. Most investors will have made in excess of 8% depending on their portfolio beta. The CoCo index has stumped up 11% year to date in total returns. The euro-denominated high yield market, is on 8.3% this year to the end of July. It’s like the market, unassisted (by QE), is in the process of smashing records. Equities have with the S&P rising to see fresh record highs having put on over 20% in 2019 to date.

The party is in full swing – although keeping it going might need some control and discipline. The demand for corporate bond risk is at elevated levels. Last week’s hybrid offering from EnBW saw a 6.2x oversubscribed book (in a holiday period) for the dual-tranche €1bn offering – and pricing tightened by a stunning and eye-watering 87.5bp between the initial talk and final pricing. The green nature of the bond might have been responsible for 10-15bp of the tightening.

Of course, there is an element of finding where the market might be, but here the ‘leads’ got it so wrong – although it might just have been good execution given that those final levels were way through fair value. Nevertheless, the issues traded down on the break highlighting a bit of ‘buyers regret’.

The warning here is that excessive tightening of deals in the pricing phase – should it continue – could well kill the goose which lays the golden egg.

Primary is still knocking out deals, though, even as many investors are away. We are on a trajectory of getting close to it being a record year for IG non-financial issuance, with July delivering €15.25bn (the best since 2014) and for the year to end July, we’re up at €181bn of deals.

Investment Grade Corporate Issuance Since 2003


Primary issuance meeting demand

IG non-financial in July was the best since we’ve been keeping record (2014), coming in at €15.25bn. Merck KGaA kicked the month off with a triple-tranche €2bn offering and we closed out with a trio of deals from Philip Morris, also for €2bn. That was all much better than expected.

IG Issuance

As for August, we already have had that Daimler offering, via a 4-tranche effort. August can be a heavy month; in 2018 (for example), we had €17.95bn issued. Back then, the likes of Seems (€3bn), VW Leasing (€2.5bn) and Michelin (€2.5bn) were the largest borrowers in the month.

So, we are now rapidly approaching €190bn for the year to date and the full-year total must be looking to have a tilt at exceeding €270bn. Tightening spreads, no let-up in demand, well over 30% of the IG market negative-yielding, the demand side of the market is holding up extremely well. Record low IG funding costs are easy to sell to IG rated corporates in order to get them into the market.

The high yield primary market has flattered to deceive this year but we have started to see greater traction through July after €6.34bn of issuance. We still are awaiting a much more aggressive follow-through in spread tightening even where we are in the IG market. That might spur more borrowers on into the market where funding levels are nowhere near the costs of a couple of years ago.

For the year to date, we are up at a little over €36.4bn and although it is difficult to judge where we might end up for the full-year, we would think somewhere around the €60bn mark is still possible.

BofA have already issued in August

July’s €9.6bn of senior bank deals represented a slowdown from the June offerings (€12.6bn) but we prefer to look at the year as a whole. The total deal flow to the end of July came in at €107bn and is just €23bn shy of 2018’s full-year total.

August has already seen BofA kick off with a transaction in the opening session and the omens remain good for a full-year somewhere in the region of €170bn.


Gimme, gimme, gimme

That rising tide continued to lift all boats, with July adding to the most amazing 2019 for just about all risk assets. IG credit (iBoxx) added 1.4% in the month, and the year to end July total return level rose to 7% for the year to end July. We dare say that most investors will have exceeded 8% for the period. Index spreads tightened by 15bp to B+110bp, while the index yield dropped to a fresh record low of 0.48%. We look for the IG spread to be close to B+100bp by the time we’re back in business proper at the beginning of September.

The AT1 market is up 11% in the year to end July. AT1 index spreads have tightened by 215bp (B+522bp, not the tightest this year), but they have some way to go to get to the B+288bp record tights. We think that is unlikely. The index yield however is at 4.51% versus a record low yield of 2.84%.

In the high yield market, not awash with deals nor any massive spread tightening, the index still returned 8.3% in the period to end July. In the UK, sterling credit spreads tightened by just 6bp in July, but the iBoxx index is up 9.7% in 7-months, as Gilts rallied hard on ‘no-deal’ Brexit fears and the longer duration index supplied a massive boost to bondholders. Away from credit, the Eurozone sovereign sector has returned a massive 7.7% in the 7 months to end July 2019.

Some slightly greater levels of volatility amid concerns around global growth and the US-Chinese trade talks, took the shine of European stocks leaving the Dax’s performance in the 7-month period at +15.9% – which was down from the 17.5% gains seen in the first half of the year. The FTSE was buoyed by the massive pressure on sterling and returns improved to 12.6% in the period to end July (10.5% in the first half).

Hawkish sentiment from the Fed despite that 25bp rate cut on the 31 July saw a material retreat in US stocks and, having been at record levels (S&P500) at the back end of the month, the weakness saw that the 7-month gain came in at 19%! For the Dow that was 15.2%. Not bad at all, considering.


Now what?

Some corporate bond investors might be tempted to take some risk off the table come September, in anticipation of potential outflows given the excellent levels of performance so far. We think that might work but there is likely some considerably more performance to be gained. Of course the event risk remains (US/China trade, Gulf oil skirmishes, macro growth)

The 10-year swap yield went negative for the first time ever, the 10-year Bund yield has reached its lowest ever yield of -0.46% and we think that the next big stop is -0.75%. We must be looking at the -1.0% level thereafter. It’s just a matter of time given that the ECB will be in action soon enough. In fact, we will likely see that -0.50% landmark yield for the 10-year Bund in Friday’s session.

As for corporate credit, returns will be moving higher as spreads squeeze tighter and the underlying continues to rally. The IG iBoxx index might have delivered 7% this year to date, but that 10% mark isn’t too far away and quite possible. For us to get there, we will need the iBoxx index spread level to see a new record low (currently B+112bp, record low B+83bp).

So, close on 10% for IG, what about 13% for HY and 16% total returns for the AT1 market (11% currently)?

Anyway, late into the opening session of the month, news emerged that the US would place 10% tariffs on an additional $300bn of Chinese goods as talks between the two nations this week seem to have hit some difficulties. The S&P fell and was 0.8% lower as at the time of writing, while the US 10-year Treasury yield sank to 1.90% (-12bp). We might need a pick-me-up to keep this party going!

Although the primary market has been a busier than expected, the holiday season is reducing the level of investor participation elsewhere. We will be back in full-flow daily format by the end of the month and will publish ad hoc before then should market conditions change.

Have a good day.

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.