23rd October 2018

Humpty Dumpty had a great fall

MARKET CLOSE:
iTraxx Main

75.8bp, +2.5bp

iTraxx X-Over

300.9bp, +8.1bp

🇩🇪 10 Yr Bund

0.41%, -4bp

iBoxx Corp IG

B+139.3bp, +1.7bp

iBoxx Corp HY

B+421.8bp, +7.7bp

🇺🇸 10 Yr US T-Bond

3.14%, -5bp

🇬🇧 FTSE 100 6049.62, ERROR 🇩🇪 DAX 12489.46, ERROR 🇺🇸 S&P 500 3152.05, -12.23

Market has lost its pizzazz…

Having already ready recorded double-digit losses for the year as we started the final week of the month, European equities took another major tumble on Tuesday. Why now? After all, the risks have been obvious for an age. While we previously brushed them aside – and we might still do that (!) – the cacophony of potentially escalating risk factors are a now a convenient and logical reason to explain the market drop, and reduce risk exposures. Interestingly while, say, the DAX/S&P are off by between 7% – 7.5% this month, which is in itself an awful decline in the indices, the rather measured bid for safe havens isn’t really suggestive of a major financial crisis in the offing.

Market rates should be heading sharply lower, if that were the case. But they are not. We believe it is because the ‘closed’ US market is still going great guns and we’re failing to decouple directionally from them in rate terms. While US growth exceeds 3.5% – 4% and higher inflation is in the air allowing for a hawkish Fed to keep the policy interest rate trajectory going north, then long-term market yields in the US (and by extension in Europe) are going to be fairly anchored. Hence, for example, the flattening of the yield curve.

Event risk abound comes in the form of slowing Chinese growth (quarterly GDP missed last week) which will impact Asia (EM) and Eurozone industrials in particular. The tensions with Saudi Arabia is the ‘fresh’ event risk situation that will be dampening enthusiasm in markets. The EU budget row with Italy rumbles on and the latter is ready to fight its corner at the injustices and unfairness of the Maastricht straitjacket. Brexit negotiations are reaching the most critical phase and a flip of the coin will settle the deal or no deal issue. And the earnings season – in Europe anyway, is turning into a shocker for some companies with equity markets punishing those who miss on earnings or lower estimates (Atos and chipmaker AMS on Tuesday) – hard.

All the market needs is a bit of confidence. That can come if some of the aforementioned situations are resolved, as they would make the situation look less bleak than at present. Most rallies otherwise will be dead-cat-bounces. But the stabilising influence isn’t coming and as we close in on year-end. So now, with just weeks to go before activity really grinds to a halt, we would think that investors are already looking at preservation strategies. And across all sectors.

In credit, there is no need for borrowers to try and get in right now. They’re cash rich and hardly needing to fall over themselves to get some funding in. If the current equity rout spreads then rates will eventually have to fall and likely credit spreads don’t gap too much. The secondary credit market is illiquid, the ECB has extracted 20% of the IG non-financial sector after all and investors are sitting on decent levels of cash. The low levels of activity come as a result of poor primary, although we concede that market illiquidity will see a disproportionate widening in spreads – if we enter crisis territory. There is no panic at the moment.

On the flip side, any subsequent calm in the markets would then be an opportunity to get deals away. The issuance drought in October and this year generally though is not a direct result of the general malaise and volatility in the markets – although that doesn’t help.


Depressingly, yet another bad day

We were watching those stock markets all day, and of course into the weakness a keener interest on the corporate earnings season. We were given a taste of things to come following weaker reports in Europe because as the US came in, 3M and Caterpillar gave us some mixed earnings. Earnings might have peaked. And those tariffs are going to bite. The future isn’t necessarily bright.

At the time of writing, the S&P and Dow were around 1% lower (off the worst levels of -1.8% in the session) and the VIX was 2-points higher at 22%. The S&P500 index is now only around 2% higher year to date, having endured one of the most amazing months for a while. Earlier in October, the index was printing a record high and gains exceeding 10% for the year, before giving back most of them since. The European bell-weather Dax index is 12% lower this year (-2.2% on Tuesday).

The rally in bonds (safe-havens) we would say has been quite measured, for reason highlighted previously. The demand for government bonds saw 10-year Treasury yields 5bp lower at 3.14% and the 2s/10s curve 2bp flatter at 27bp, it has been flatter recently. In Europe, the 10-year Bund yield only fell to 0.41% (-4bp) while the DAX lost 2% in the session while Brexit-riddled UK markets saw Gilt yields decline to 1.49% (-4bp) on hopes of an EU/UK agreement on the Ireland backstop.

For Italy, BTPs underperformed, with the 10-year yield up at 3.60% (+12bp) and not the worst it has been of late (3.78% last Friday) – even after the EU rejected the latest budget proposal and requested changes to the current plan.

The corporate primary market wasn’t closed although most of the issuance was confined to SSA and covered bonds. Netflix was the lone borrower for the corporate sector as it printed €1.1bn in a 10.5-year maturity at a yield of 4.625% versus initial talk of 4.50%. A rare reversal but understandable given the current market conditions and a pragmatic response from a US borrower that we have come to expect.

With this sharply lower equities, there was obviously a defensive tone in the credit market and the cost of protection rose. iTraxx Main rose 2.5bp to 75.8bp and the X-Over index rose to 300.9bp (+8.1bp).

In secondary cash, most were sidelined, with few daring to execute (sell) into what would be an extremely defensive bid, while any offered side liquidity (for those looking to pick off paper) was also extremely unappetising. We were obviously marked wider, and that meant that the iBoxx IG cash index was up at 139.3bp which was just 1.7bp for the day. The CoCo index was up at B+569bp (+13bp) which is over 200bp wider this year, and the highest level since Q2 2017 – unfortunately understandable given the machinations around the Italian budget and those big declines in equities.

In the high yield market, Netflix’s deal was the distraction. It helped contain the weakness the high yield market (index) to just 7.7bp and it closed at B+421.8bp.

Overall, time to stay sidelined.

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.