14th July 2019

Here comes the summer sun…

MARKET CLOSE:
iTraxx Main

49.3bp, -0.1bp

iTraxx X-Over

245.9bp, -0.1bp

🇩🇪 10 Yr Bund

-0.25%, -1bp

iBoxx Corp IG

B+116.5bp, -0.5bp

iBoxx Corp HY

B+402.8bp, -0.5bp

🇺🇸 10 Yr US T-Bond

2.12%, unchanged

🇬🇧 FTSE 100

7188.50, (-0.70%)
🇩🇪 DAX

13140.57, (-0.65%)
🇺🇸 S&P 500

3112.76, (-0.07%)

Markets play it cool…

Equities in the US into record territory, rates giving up some of their stellar gains and IG credit spreads at levels not seen since May 2018. A dovish Fed has laid the foundations for a rate cut at the end of month FOMC meeting, and the ECB looks as if they will also cut the deposit rate and/or announce a new QE programme. Equities will get a further boost, rates will recover their recent losses and yields will plunge lower while credit spreads will tighten some more as we set the stage for a post-summer rally.

We’ve had far less primary than might have been expected last week and it would appear that the markets have pretty much wound down for the holiday period. We barely added anything in IG, the HY market is yet to see a deal this month – while financials have been busy with some well-received and testy AT1 offerings appealing to the yield hogs.

IG credit spreads have ground out some further performance and the IG iBoxx cash index has tightened to B+116.5bp. That represents 9bp of tightening this month, while returns are only marginally off their year to date highs and up 0.25% in July.

In high yield and other high beta markets (CoCo market for example), it is not a case that the demand and fund inflows are beginning to price a market for perfection. It’s more about being pragmatic. Investors need higher yielding assets, the ECB might be back hoovering up the IG market and underlying yields are going lower. Portfolio performance can (and likely, will) follow.

A recession will not necessarily lead to a major hike in the default rate and large losses for investors. We’ve had a couple in the post-crisis years, yet the default rate anywhere hasn’t picked up at worst past 3% in any year. At less than 1% now in Europe, the continued difficult macro environment has barely pricked the high yield ‘bubble’ – and HY credit spreads are nowhere near their tights of a couple of years ago.

The wall of funding has shifted out to beyond 2021, and refinancing looks like it isn’t as onerous as it might have been (pre 2010) into macro weakness. So the ability for the high yield corporate universe to refinance and service obligations is very good. Should the tea leaves line up, the index could sustain a market tightening 25-30% from these levels. The iBoxx index is currently at B+403bp versus a record index tight of B+254bp.

Profit warning for BASF

The 10-year Bund yield rising to -0.25% from -0.40% in a week makes that -0.50% target – let alone our -0.75% one, seem a long way off. Almost impossible, one would think. We’ve had a few more profit warnings (Daimler and BASF the latest) while the bounce in industrial production across the Eurozone in May looks a spurious event against the broad macro weakness.

The announcement of some sort of ECB action might give rate markets a leg up and push those yields towards those lower target levels. We still hold firm that those rate markets are set to rally some more and push many other markets deeper into record territory – and that includes the IG credit market, with around 34bp of tightening to go (iBoxx index) before it reaches such a level.


Primary winds down

Jefferies Group was the pick of the deals on Friday as it issued €500m in a 5-year at midswaps+120bp, off an order book of €2bn and 30bp inside the initial price guidance. For the week as a whole, financial issuance dominated, but we had only €2.5bn of senior issuance.

FinecoBank‘s €300m AT1 issue took in orders of €2.75bn and pricing for the 5.875% issue was 62.6bp inside the initial guidance. National Bank of Greece’s €400m 10NC5 priced to yield 8.25% (-75bp inside the guidance) attracted €1.65bn of orders in another eye catching offering for the triple-C rated issue. The other deal worth a mention was Aroundtown’s €500m perpNC5.5 hybrid which came with a coupon of 3.25%.

IG non-financial issuance this month so far comes in at €8.8bn and our target of up to €15bn looks a stretch now, with just €3bn printed last week (we include Logicor). For the year to date it’s a decent €175bn and still leaves us on target for somewhere in the region of €270bn for the full-year.

High yield issuance in euros opened up its account on Friday as House of Finance’s €320m 7NC3 senior secured offering was finally priced at 4.375%.


Time for the grind

So the pull back in rate markets has had an impact on performance for credit market total returns investors, though few will be concerned. Spreads continue to grind tighter and have generally capped off the weakness. At this halfway stage of the month, we are up 0.25% in total returns returns, 9bp tighter in spreads and overall sitting good for the year to date.

The high yield index at B+402.8bp has tightening 16bp this month and returned 0.5% while the CoCo index is 23bp tighter at B+500bp (-210bp YTD) and returned +0.7%. So despite the big sell-off in rates last week, credit performance (total return and benchmark) remains in the black.

The synthetic markets didn’t do anything as we closed last week’s final session left at 49,3bp for Main and iTraxx X-Over at 245.9bp.

The headlines, though, will be that record close the US which came against the backdrop of that uptick in Eurozone industrial production, Chinese exports coming in better than expected and another quick fire profit warning from Daimler. It’s a mixed bag, but the market expects… a Fed rate cut as well as some ECB action (rate cut/QE). So we are likely going to trade those expectations until the next FOMC which comes July 30/31.

Results are due this week for JP Morgan et al

The S&P closed at a record 3,013, European equities closed unchanged while rate markets did very little, either. The 10-year Bund yield was at -0.25% and the US Treasury closed at a yield of 2.12%.

As for this week, it’s US earnings season time with Citigroup kicking us off on Monday with JP Morgan, Goldman and Wells Fargo following on Tuesday while the likes of Netflix, Microsoft and J&J also due this week. There’s much by way of macro data while the EU is expected to vote in its new president.

Have a good day. Given the slowdown in activity into the holiday period, we are back on Thursday.

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.