19th July 2016

Holidays are coming

MARKET CLOSE:
FTSE 100
6,695, +26
DAX
10,063, -3
S&P 500
2,166, +5
iTraxx Main
71bp, unchanged
iTraxx X-Over Index
326bp, unchanged
10 Yr Bund
-0.02%, -2bp
iBoxx Corp IG
B+131bp, -1.5bp 
iBoxx Corp HY Index
B+421bp, -0.5bp
10 Yr US T-Bond
1.53%, +3bp

ECB hammering harder…

ecb-buildingAll eyes were on the ECB again with the latest report on its corporate bond holdings, as well as the first monthly update of their actual holdings. The first four weeks saw the ECB do some seriously heavy lifting as it accumulated €8.5bn of IG non-financial corporate debt, and with a weekly run rate of over €2bn dropping to under €1.7bn by the time the fourth week came about. In yesterday’s session, they reported that their total holdings had increased to €10.4bn, thus taking €1.95bn of corporate bond debt permanently out of the market in week number 5. They continue to show their intentions – and they are being very aggressive. Policy intentionally driving spreads lower, crowding out investors, and letting the markets assume more risk – with the ultimate aim being that the market funds lower rated entities.

ISIN numbers of the bonds the ECB holds were released and that was about it. There will be no information on the size of any particular holdings, although we can get some idea of the maturity, rating and sector distributions – once we (or someone) has sifted through all the data! We’re not sure what we would garner from that – they will just lift what they can that fits the remit they have put out. Anyway, the initial readings see the longest tenor being the RTE and ABInBev 36s. The smallest deal they have a holding in is the Heineken 23s (€140m at issue) and the lowest yielding bond the Deutsche Bahn 18s (-0.25% bid side). Some 100+ of the bonds are negative yielding with the X-Over names being EdP, Telecom Italia, TVO, Lufthansa and SDF. And the rest saw utilities, consumer and communications companies – in that order top the list; with Germany, France and Italy the geographic winners – also in that order. And that is pretty much reflective of the biggest sector issuers and geographic borrowers.

The big figure though in itself is enough, in our view, to know that the whole market has been structurally distorted. With that comes much upside vis-a-vis lower costs for borrowers or improved performance for corporate bond holders – so long as this party continues. The downside is that investors take on a disproportionate (and in many cases an uneducated) amount of risk; while any sustainable turnaround in global macro breaks the corporate bond markets backbone as we rotate into equities. That could be a good while yet, admittedly.

Credit shining brightly

It is absolutely no coincidence that the ECB’s involvement has resulted in a crunch tighter in corporate bond spreads. There was some weakness in spreads post-Brexit, which was to be expected – but that widening came without the corresponding level of selling which we might have expected in order to justify the big move. However, since then, we have seen some significant moves in the Markit iBoxx corporate bond index. After an index level of B+160bp immediately following the session when the referendum result was known, we are 28bp lower now, and 12bp tighter since June 8 – when the ECB started buying. And we are 14bp tighter in the last week. Some of that might have come as a result of the risk-on nature of the markets in that period, but we think for our illiquid asset class, it is more to do with the central bank sucking liquidity out of the market. And squeezing valuations higher as paper becomes more scarce.

The index yield is at 0.96% and sets the record low for it. We are targeting a yield level of 0.70% with the contribution to now come mainly from a tightening in spreads, with the underlying likely to boost the level by less now. Lower and declining government bond yields have done much to get us to these record low corporate bond yield levels, but we think that another 30bp of tightening in corporate bond spreads into year-end will see us closer to our target level (we look for spreads to be at around B+100bp from B+131bp currently, and that’s against a record low of B+94p).

Interestingly, the HY market closed with spreads pretty much unchanged, the Markit iBoxx index at B+421bp. The iTraxx indices also closed unchanged with Main at 71bp and X-Over at 326bp.

No Brexit hangover

Almost three weeks on, and we’re still waiting the doomsayers’ outcome of the post-referendum result. No financial collapse, no signs yet that consumption is particularly waning, or that investment has been severely curtailed. And the BoE has not been called into action. Indeed, in Monday’s session we had the BoE’s MPC member Weale suggest there is prudence that comes with waiting, and that an August rate cut and/or other measures were not a done deal. That contrasts with comments from some other members. So we go on, let the politics play out while the markets go through their usual summer dullness and we position for the September rush (of issuance) to see out the year.

Other than that there was little going on; ARM Holdings was acquired by Japan’s Softbank for £24bn, and there was the usual shuffling in geopolitical circles around Turkey and what happens next. Equities played out in a small range but mostly in the red and government bonds assumed a better bid with yields declining a little. The primary market gave us only a deal in senior funding from JP Morgan while on the earnings front, BoFA had a decent quarter but did see a YoY decline in net income as the low rate environment eroded margins/income.

And that’s it. The US closes at a new record high for the S&P, UK PLC chugs along with the mega post-Brexit acquisition of ARM by SoftBank a confidence boost, and we look forward to the ECB’s heavy lifting of corporate bonds for this market to do away with any volatility we might see in elsewhere through the summer weeks.

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.