6th June 2018

Hawkish sounds from the ECB

MARKET CLOSE:
iTraxx Main

69.7bp, +2.6bp

iTraxx X-Over

300.9bp, +7.5bp

🇩🇪 10 Yr Bund

0.46%, +9bp

iBoxx Corp IG

B+127bp, unchanged

iBoxx Corp HY

B+375.5bp, -1.3bp

🇺🇸 10 Yr US T-Bond

2.97%, +5bp

🇬🇧 FTSE 100 , 🇩🇪 DAX , 🇺🇸 S&P 500 ,

…Raise alarm

We’ve been hoping for a good June. But we keep hitting hurdles which stop us rallying in any sustainable or material way. There’s just a constant drip feed of news which makes us wary and then unwilling to chase the markets higher.

On Wednesday, safe-havens sold off some more after word from influential ECB board members that the Eurozone’s economy was looking in decent shape bolstered the view that QE could be over come year-end. They meet next week. Equity markets wanted to rise, but the rally was checked – not helped also as the EU prepared its US import-tariff response, expecting them to be implemented by the beginning of July.

Bond yields rose and BTPs underperformed as the markets reflected on both PM Conte’s words in the Italian parliament on Tuesday but more on those hawkish ECB board member comments. Funding costs are going up for Italy (and everyone else) just when the country calls out for fiscal profligacy. The yield on the benchmark 10-year was as high as 2.98% in the session but managed to close at 2.90% (+15bp).

These are big intra-day moves and highlight the considerable nervousness amongst the investor community emerging from the political uncertainty in Italy where events could go badly awry very easily. And yields there rising by 15-20bp intraday is bound to have a negative impact on corporate bond holders, especially those holding Italian (and other) bank credit risk.

We shouldn’t be surprised with all that. What was a little surprising was that the primary market proffered nothing in the corporate bond sector. We know that the pipeline is in excellent shape and deals are going to come, but now would be good timing for a borrower or two to get a deal away given that there are so few deals on the screen outside the SSA sector. Especially when we look at how Carrefour, as an example, managed to get a very good reception to its deal on Tuesday – even if it was cheap. The primary window is wide open.

Furthermore, the recent weakness in secondary has halted. There really is no panic in the corporate bond markets. The not too insignificant spread widening through May was driven by illiquid secondary markets and an unhelpful, extremely defensive Street bid (why shouldn’t it be so?) into the eye of the recent storm leaving us with an exaggerated spread widening.

As we suggested in Tuesday’s comment, we have snapped back a little and should a more constructive tone persist, we could reasonably expect the spread tightening to continue. At least with the last couple of sessions’ weakness in Italian government bonds, the weakness is credit spreads has been more focused and limited. Investors are probably now better positioned for further volatility which might come from Italy. The market obviously isn’t for the ending of QE!

Elsewhere, the trade tariff situation will be a slow-burning fuse and news flow here appears to be having a lesser impact on markets. The ECB and Trump/Jong-un meetings – both slated for next week, are probably the next big deals for the market.


Rate markets under fire

Most of the ‘good work’ through May was undone in Wednesday’s session in the rate markets, with yields jumping higher. We know the end of QE is nigh, but the fear of it becoming a reality shook a few nerves, having a significantly negative impact on rate markets.

The 10-year Bund yield jumped a massive 9bp to 0.46%. The equivalent maturity Bono yield rose 11bp to 1.50%, and the OAT to 0.82% (+11bp). Even Gilt yields were dragged higher by 9bp to 1.37%, while US Treasuries fared a little better, the yield on the 10-year up at 2.97% (+5bp).

Where we go from here will depend on the prevailing data into next week’s ECB meeting, and then how the ECB portrays the outlook as the market scrutinises every word Draghi utters in the press conference for clues. The Eurozone economy might soon be standing on its own feet – just over a decade since the crisis started.

In credit, the long-term implications for corporates are higher funding costs. So they may as well jump the gun and get in ahead of the curve (and the herd) with any additional necessary, or otherwise, funding requirements. For investors, total returns are going remain anaemic or negative as the underlying sells off faster than spreads tighten. Classically, spreads should tighten as economic recovery sets in. But such has been the extent of the market’s manipulation by the central banks, it’s difficult to judge the directionality of spreads – into a supposed economic recovery.


In need of a pick-me-up

So primary drew a blank, and the session petered out with investors focused on the ECB. Croatia‘s €750m 10-year sovereign issue priced at midswaps+190bp was the main deal of the day. We think a corporate borrower, as suggested above, could have got a deal away in the session, even against the backdrop of rate market weakness.

Equities closed out in mixed fashion, small up (+0.3%) or down (-0.1%) as investors sought to jockey for position. Rates were under considerable pressure. News flow generally was quite light and few paid much attention even to last month’s improvement in the US trade deficit, preferring to look at the longer term trend which is not so encouraging for the US administration.

In credit, the iTraxx indices predictably moved higher unable to break free from the defensive mood prevalent in other markets. iTraxx Main closed 2.6bp higher at 69.7bp and X-Over was higher at 300.9bp (+7.5bp).

So secondary cash was extremely quiet, but not as defensive as we might have expected. The cash market was in mood to deviate from the masses, or it has learned the lesson from last week. So we didn’t succumb and we closed unchanged, the iBoxx IG cash index at B+127bp. In high yield, we closed a touch better! The high yield index was left at B+375.5bp (-1.3bp). Light at the end of the tunnel?

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.