28th April 2016

FOMC gives us a break

MARKET CLOSE:
FTSE 100
6,320, +35
DAX
10,300, +40
S&P 500
2,095, +3
iTraxx Main
71bp, unch
iTraxx X-Over Index
302bp, -3bp
10 Yr Bund
0.29%, -1bp
iBoxx Corp IG
B+139.4bp, +0.5bp 
iBoxx Corp HY Index
B+480bp, +3bp
10 Yr US T-Bond
1.85%, -7bp

Taking stock – with a rant…

Fear of the unknown can make for a herd-like mentality to investing. With the ECB due to start lifting our market, we are positioning ahead of the event and prepared to buy the richest of corporate bond debt in order to get some performance in. Breakevens are crunching lower and we have little room for error. But then everyone is in the same boat. There’s always been comfort in numbers. Take a look at the German government bond market. 10-year yields had fallen to 7bp a couple of week ago and we, for one, thought they would see record lows: they are now up at 30bp. It’s the second time this has happened. The corporate bond market is a slightly different beast to government bonds and can be riddled with event risk, poorer liquidity. But the sheep-like trend of investing is, and always was, very prevalent.

Brexit: Herd mentality works for corporate bonds

Brexit: Herd mentality works for corporate bonds

And we move on to Brexit. The OECD joins the long list of “credible” organisations and politicians stating the obvious: vote to remain in, as the huge uncertainty which comes with a vote to leave would unleash a tidal wave of volatility. And we could all do without that. Better the devil you know than you don’t. We won’t get too political here, but we would say that the herd mentality works for corporate bonds because performance is all relative.

We know what’s coming and we have a good handle on the variables which make up the equation: supply plus demand plus ECB equals tighter spreads. And we know that when we get the inevitable turnaround, the door will be slammed shut. For Brexit, the unknown is an exciting proposition and perhaps enough of a reason and a lure to leave.

Because the FOMC made for a quiet session

Cook- Apple

Big fall in sales: Apple

Heading into that FOMC communiqué’s slipstream usually leaves a subdued market session, and that’s what we got – even though expectations from all quarters were for nothing untoward to emerge. IG non-financials drew a blank in this already record April month for issuance for this category of debt, while there were a few deals looking to get priced/being marketed in HY. In financials, the lone transaction came from Unione di Banche Italiane (UBI) in subordinated funding, in the form of 10NC5 Tier 2 notes (rated Ba2/BB/BBB-). The overall newsflow was focused on UK GDP (in line with expectations, but the lowest rate in 3 years); a resilient German consumer, judging by the latest survey; and a host of earnings reports which turned out to be quite mixed. There was nothing as disappointing as Apple’s report on Tuesday evening.

And then there was oil. Trading with a $26-handle per barrel in January and seemingly heading toward $20, we’ve seen a huge recovery in the price, which almost doubled to close on $46.5 per barrel (Brent), having touched $47. The rig count in the US has dropped, which ought to be supportive for prices – until they get a little higher and idle rigs come back online. Demand seems stable though, while there has been little progress on the production freeze some OPEC members have been hoping for. Maybe it was just on oversold positions and that momentum-like trading we mentioned above that we saw $26 per barrel.

Before the FOMC, it was like this

European stocks traded in a small range in and out of the red/black before settling to close the session a touch better. Government bond markets traded up a little and yields fell back a touch. The 10-year Bund yield declined to 0.29% (-1bp), with Gilts having the upper hand as the 10-year yield dropped 3bp to 1.62%. For the latter, Brexit news flow will likely be the determining factor as far as intraday volatility is concerned.

In credit, it was rest day and an opportunity to collect our thoughts ahead of the new month. We’ve had a decent amount of issuance to absorb this month and the dynamics of the pricing process have been frustrating and testing, but we see that most issues – although tightened up by an average of 15-20bp versus those IPTs – have been performing well. That’s probably a signal for the banks to maintain the status quo of the pricing process. That is, go out with a wide/cheap IPT, build a huge book, then ram in the level and if a few drop out, so be it. The fragmented and non-uniform nature of the market will usually ensure enough stay in and enable deals to get away.

The Markit iBoxx IG index closed a little wider at B+139.4bp as some higher beta risk sectors came under pressure. That was most noticeable in the corporate hybrid market, while CoCos were actually better placed relatively and closed unchanged. Still, it wasn’t a particularly exciting session leaving us with the usual low flows and volumes with which we have become used to. The HY index ended at B+480bp and just a touch weaker. Noise.

And finally, the FOMC decided….

To get all bulled up. Well, not quite, but the committee was happier with the macro outlook and we expect the markets will become all cock-a-hoop that they’re going to raise rates come June. That leaves us with 6 or 7 weeks of intense data watching, excited commentary and likely volatility in most markets. They’re diverging from Europe. And that means we’re back to thinking euro credit outperforms dollar corporate bond risk.

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.