- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
|FTSE 100 ,||DAX ,||S&P 500
‘Twas ever thus…
Oooh. Aaah. And then a sense of pragmatism as we had a think about last Friday’s non-farm payroll report. The US economy lost 30,000 jobs against expectation of an addition of 80k. But hourly earnings rose to 2.9% in September versus 2.7% in August. And we all got comfortable that the Hurricane Irma had a significant and material impact on the number. The next NFP number or two could be huge. We ignored the big figure this time, and focused on the wage increases. A rate rise is coming in December, according to the futures market and a recovery in jobs growth over the following months will have us all believe that the US economic growth is following a steady path upwards, even if it is not going all-out gangbusters.
The payrolls report nevertheless put a stop to yet another record-breaking close in the US stock markets – but by only a small margin, as the S&P dropped less than three points and the Dow by just a couple (the Nasdaq set a new closing record, by the way)! But that will only be a temporary pull-back in our view because as we digest the data, decide that US economic growth is sustainable and that rates are not going to the moon quickly – we can resume that inexorable climb higher in equities, as well as in other risk assets. The market wants to rally.
That means good news for credit spreads too, for this final quarter at least. There is still, after all, a Goldilocks feel to the recovery we are seeing at the moment. The conditions are still kind to – almost perfect for – the credit markets. Nothing too hurried (growth, inflation, withdrawal of liquidity and so on), just calm & measured and a slow reinstatement of normal policy conditions. So Friday’s market reaction was fairly muted, all being told. Despite that equity market decline in the US, rate market yields only edged a touch higher but credit spreads were tighter.
The synthetic markets (on the face of it) didn’t buy into the potential for a continued supportive environment for credit risk. But they were wider – more because of the ongoing uncertainty in Spain/Catalonia and the event risk which might come from it. So buying a bit of protection was always going to be trade for choice going into the weekend. iTraxx Main closed at 56.7bp (+1.3bp) and X-Over was up at 247.5bp (+3bp).
High(er) yield has it all – arrange your chips
Ok. It’s really just noise in terms of the spread moves, but they’re pretty much back at record tights in the high yield market. We refer to the Markit iBoxx IG cash high yield index which closed at B+277bp on Friday, just 0.5bp wider than the record low seen on this index back in early August. This is not as good as it gets, either. After dismissing that non-farm payroll report, the market will be upbeat as to the jobs numbers for the next one, and equities should be on the up into expectations of that continued growth recovery. That will act as a boost for tighter spreads even if rates might edge a little higher. On the other hand, if the next report isn’t well-received (NFP lower than expectations by a considerable margin), then the doubts about rate increases will boost the demand for higher yielding risk – and will serve to tighten spreads in this market again (in dollars and euros).
Furthermore, the index yield is just 2bp off the record low, now at 2.64%. We think that the spread-tightening dynamic will outgun the potential for any rise in front-end European rates, and so that record low is at risk as early as during this week’s business.
With those low/record yield/spread numbers, an increasing number of investors are going to be concerned that value in this market is now at a premium and might – or will – be looking for their booty elsewhere. For example, like in the AT1/CoCo market. Well, apart from mandates not allowing some portfolios to buy higher yielding financial products and so on, the high yield market is a much bigger one than the CoCo market. Investors in most cases will stay put. After all, it’s not to be scoffed at that the high yield sector has returned almost 6% this year so far – and we think that will rise over the quarter. That level of total return (spread tightening 136bp, or a massive 1/3 of the index) surpasses even the most bullish of expectations.
Still, the CoCo market has also had a super time of it, returning 13% this year-to-date and spreads on the index still have 20bp to go before they get to the record lows seen in early August. What’s good for the traditional high yield market’s performance is also good for the contingent convertible one. Place your bets.
Reason to stay upbeat
The third quarter earnings season beckons and might curtail some primary market activity. It might also have a bearing on the direction of US equities, in particular. JP Morgan, BofA and Citigroup loom large. We’re sure they will beat expectations and any misses will find excuses – Hurricane Irma, of course.
For credit markets in Europe, focus will be on pre-earnings blackout period corporate bond issuance. We haven’t been impressed by the amount of issuance seen these past few weeks. Last week saw just €4.2bn in non-financial IG supply, while a flurry of late pricing at the end of last week saw €2.1bn of HY issuance – and took the YTD total to past the €50bn mark, leaving us with €7bn of supply to go for the year to close out with a record.
IG credit closed unchanged on Friday, effectively leaving the Markit iBoxx cash index at a touch under B+107bp. The high yield market was better bid, as highlighted above, and the index left at those record lows. Should we get a positive start to proceedings as we open for business this week, spreads will be marked tighter – even if we don’t get the corresponding flows to justify it. The omens for credit/spreads are good for this final quarter.
More immediately, all eyes will be on the developing situation in Spain/Catalonia.
Have a good day.
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