- by Suki Mann
|iTraxx X-Over Index
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY Index
|10 Yr US T-Bond
A little bit of bad is good…
Who’s going to be the first to come out with the “sell in May…” cliche and say “I told you so”? After a very poor session, one would be forgiven for thinking that we are in for a long old grind through this month. We were hit with a barrage of negative news. The European Commission downgraded its eurozone growth and inflation forecasts – again – for 2016/7, while the UK’s manufacturing sector contracted in April. The euro and sterling currencies continued to strengthen against the dollar, with the former seeing $1.16. The ECB will not be best pleased. That will keep a lid on inflation in the eurozone, although producer prices did manage to rise a better than expected 0.3% in March. Stocks took a pummelling, approaching almost 2% of losses across the board, while government bond yields regained a better bid on safe-haven dynamics. Even gold is back in the picture. Corporate bonds managed to hold their ground – almost oblivious to the weakness elsewhere, with spreads barely changed – and we all know why. The iTraxx indices however illustrated the risk-off nature of the session for credit markets as they jumped higher.
Macro weakness – so long as it is no disaster – means easier policy for longer and easier (or rather cheaper) funding conditions for longer. After all, low rates and growth at these very low levels over the past few years have left the corporate sector’s credit metrics in great shape. We are eight years into the crisis, and corporates’ ability to service their debt remains the best it has ever been. And it will continue to stay this way, while support from the ECB will allow the corporate bond market to weather the bouts of volatility we are seeing elsewhere.
The improved debt metrics are highlighted in the latest default statistics released by S&P, which showed that the 12-month trailing European default rate rose to just 1.6% in April as two borrowers defaulted, while the drift ratio improved as more corporates (13) were upgraded than downgraded (10)! The downgrade ratio is now at a 3-year low at 0.77:1 (versus 1.53:1 in 2015, for example). In the US, where the cycle might be in a different phase – or just different – it is another story. The default rate is up at 3.9% and 15 companies were upgraded versus 52 downgraded, leaving a downgrade ratio at 3.47:1 (versus 0.89 in, say, 2013 and 2.18 last year).
Buoyant primary keeps credit on the front foot
The deal flow was very good, and this part of the market completely ignored the poorer session elsewhere. We had some €5.1bn printed in IG non-financials in this opening session proper of the month from Daimler, Orange, RCI Banque and Philip Morris, and receptivity to these deals was excellent. Pricing for all was tightened by 12-17bp versus the initial price talk, although the 20-year Philip Morris deal was just 5bp tighter. And we now have to admit that a trend is in place for the foreseeable future.
That is, cash credit holds its ground when stocks fall and spreads edge better when equities rise. That without a new issue market, the corporate bond market threatens to become as dull as ditchwater. And we’re going to need a knockout event to see any of this change, as the shadow of the ECB’s buying programme starts to creep up on the euro-denominated corporate bond market.
It was Daimler’s third three-tranche visit to the market this year, and it has taken €10bn in the process. The total is only bettered by the €13bn or so printed by ABInBev in the financing of the acquisition for SABMiller. The auto maker nevertheless seems to be in a hurry to get deals away, but we believe this is unnecessary. Our view is that the markets and pricing will remain receptive to them – and others – all year. In fact, they ought to improve. Anyway, they printed a total of €3.25bn in 4, 7 and 12-year maturities, while phone operator Orange lifted €750m in 9-year funding. We had RCI Banque take €600m in an unusually long – for it – 7-year deal. Finally, Philip Morris plumped for 20-year funding at midswaps+90bp, taking €500m for its troubles.
Ouch! What a way to start
With the bank holiday in the UK on Monday, proceedings kicked-off proper in yesterday’s session. And there was weakness from the very start. Economic reports veered towards continued, if not more weakness and there was a dash of sorts for quality assets. Government bonds and gold were those havens while there was a sea of red ink over stocks. Corporate bonds sit somewhere in between and while cash was just a tad weaker, the greater weakness was with the synthetic indices as the cost to insure credit/positions rose. In equities, the DAX dropped through 10,000 where it has spent most of the year anyway, and is almost 7.5% lower since the beginning of the year, while the S&P gave off over 1% at one stage before clawing some back to end 0.8% lower.
It was not all bad, the good saw government bonds crunching higher in price such that the 10-year bund yield dropped to 0.20% (-7bp) and this will have helped corporate bond returns. The US Treasury 10-year yield fell 8bp to 1.80%. On the other hand, oil prices fell with Brent succumbing to finish 1.2% lower at just around that $45 per barrel level.
Cash credit saw a little weakness but, given the fall in stocks, that weakness was noise in the big scheme while the drop in the yield of the underlying saw returns ratchet higher. The high yield market was weaker too, but spreads moved to B+484bp (+10bp) and the performance here was worse than in IG. Perhaps some notice needs to be given to those default statistics and we need more faith. iTraxx Main closed at 76bp (+3bp) and X-Over at 322bp (+10bp).
That’s it. Have a good day.