6th December 2016

Renzigned!

MARKET CLOSE:
FTSE 100
6,745, +16
DAX
10,685, +171
S&P 500
2,204, +12
iTraxx Main
78bp, unchanged
iTraxx X-Over Index
328bp, -4.5bp
10 Yr Bund
0.33%, +5bp
iBoxx Corp IG
B+139.25bp, +0.25bp 
iBoxx Corp HY Index
B+448bp, -4bp
10 Yr US T-Bond
2.38%, unchanged

It’s all about the US, and nothing else matters…

Renzignation for Matteo after result

Renzignation for Matteo after Italy decided

What a reaction! Measured calmness personified. The Italians rejected constitutional reform, effectively gave a resounding thumbs down to the establishment as we know it in Italy, and yet the markets were in risk-on mode. The opening skirmishes might have been around taking a defensive stance but once the markets had woken up properly, they moved to recoup the earlier losses.  However, that was mainly around the euro, while credit was essentially unchanged having opened weaker.

The markets have effectively faded the weakness – like other potentially crisis invoking periods (Brexit and Trump, to name but two). Those two situations might seem like they don’t matter too much for the moment, while it appears that the rejection of constitutional reform and Renzi falling on his sword does not ring too many warning bells either. It’s all about the US economy (see later).

Around Italian debt in corporate credit land, the markets were fairly subdued and offered side liquidity non-existent. Non-financial Italian corporate debt moved a little tighter but investors looking to reduce position underweights were frustrated in their attempts to do so. The Street is inventory-light and the days of going to short to help clients has long gone.

The banking sector might have had a very volatile day in equities (lower by up to 7%!), but their corporate bonds having initially been marked wider at the open (perhaps by 10bp in senior, up to 20bp wider in LT2 and down maybe 2-points in CoCos as an initial indication) soon moved to being flattish as we closed out the day.

After several weeks of weakness in corporate bond spreads, we had the perfect opportunity to push on and drive them wider some more. That Italian vote stemmed the tide, it seems. Performance unfortunately will be heaping much pain on total return investors owing to the broad back-up (across the curve) in government bond markets. The 10-year Bund yield was higher at 0.33% (+5bp) and the Gilt yield for the same maturity rose to 1.40% (also +2.5bp) – both off the session highs of 0.38% and 1.45%, respectively. Italian government debt was the underperformer, with 10-year BTP yields rising 12.5bp at one stage (to 2.06%) before closing out at 1.98% after a late recovery. These higher yield levels will immediately cut into fixed income and credit returns even if spreads don’t change.

The primary market was closed, with borrowers no doubt advised by bankers to hold fire. They called that wrong as we believe the receptivity to a deal or two would have very good.

ECB bond buying continues at high rate

As seen from the chart below, the ECB’s purchases last week totalled €2.01bn versus €1.9bn the week before. Their total purchases are now up at €48.24bn over 26 weeks – and a good two months’ worth of gross IG issuance. The €50bn will be up by the time they report next week. It is an incredible amount of purchases and has gone some way to stemming the tide of weakness that had impacted spreads through November.

The poor liquidity of the secondary market – and the offered/bid side Street interest being very limited and difficult to gauge – would have seen to it that spreads would have gapped much more through November. It’s almost as if the ECB has been that shock absorber (to some extent) which the corporate bond market has sorely needed in times of weakness – however long that period of weakness might turn out to be.

ECB’s latest weekly purchases

Interestingly, they haven’t lifted much more than the average €1.85bn on too many occasions. Judging by some of the (out)flows, we think they could easily have taken more down. Perhaps there is an implicit understanding that a range of €2-2.5bn is about the most they will lift in any given week.

Markets expecting great things from the US

Non-manufacturing ISM activity shot through the roof and the expectation now – as seen in the reaction from the market – is that the US economic juggernaut will be lifting all boats. With fiscal profligacy to come, they can’t but not pull global activity up by the bootstraps. During the session, the Dow set a new record intra-day high (19,275), European stocks rallied by up to 1.6% (DAX) but bond yields continued to rise.

Corporate bond spreads stabilised into the risk-on tone (but nervousness remains around returns declining so late into the year as the underlying sells off) as well as fear of the rotation trade (we think, perhaps in 2017) which stopped us from rallying noticeably. Corporate bonds endured a lacklustre session.

So, the primary market drew a blank in supply with not a single deal anywhere in euros. We would have thought a low-risk SSA borrower might have popped up. But we drew a complete market blank. The signs are ominous that we are unlikely going to see much now, save for the odd borrowers in IG, while we can expect a higher level from HY if market volatility stays low, given the number of deals in the pipeline. We’re going to tick over into the end of next week. Then close.

In secondary, the Markit iBoxx IG corporate cash  index closed at B+139.25bp – pretty much very slightly better offered for choice. That’s a little disconcerting given the rally in equities. It’s also the highest yield level on the cash index since late May (at 1.34%), while the spread isn’t even at the highest level versus the B+141bp seen last week. The sterling market is outperforming – completely unchanged in yield and spread as measure by the index.

Finally, the high yield market saw some support (higher equities helped?) and closed 4bp tighter for the index at B+448bp. That was a good result and suggests that weakness right now in corporate bonds is derived from the weakness in rates markets and the greater impact rising yields have on investment grade risk returns versus the high yield sector. The iTraxx indices closed with Main unchanged (at 78bp) and X-Over at 328bp (-4.5bp).

Back Wednesday.

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.