18th October 2016

Inflation giveth, low growth taketh away

MARKET CLOSE:
FTSE 100
6,948, -66
DAX
10,504, -77
S&P 500
2,126, -6
iTraxx Main
74bp, -0.5bp
iTraxx X-Over Index
336bp, +3bp
10 Yr Bund
0.05%, unchanged
iBoxx Corp IG
B+124bp, unchanged 
iBoxx Corp HY Index
B+425bp, -1bp
10 Yr US T-Bond
1.77%, -3bp

Mish mash points to an inflexion point…

It was always going to be a difficult open when we are greeted with headlines such as 10-year Gilt yields going sharply higher – again, Bund yields for the same maturity up at almost 0.10%, Asian stock markets lower and an earnings update (this time from Pearson Group with a trading statement) highlighting sharply reduced revenues – followed by a 10% drop in its stock price. The new deals came early mostly in the form of covered bonds and SSAs, but little – rather nothing, to be precise – from non-financial corporates.

And so another week beckons where we might be heading into choppier climes for equities and government bonds. ‘Twas ever the case for October. And we have another potential headache emerging in the form of inflation – but in an environment beset by a low growth dynamic. That is the case for both the UK (especially so) and the Eurozone. Suppose we “give” with one metric and “take” away with another.

While the low growth/high inflation scenario potentially plays out, bond yields managed to pull back from their highs in the session but continue to highlight the markets nervousness. Gilts have definitely been in shaky mode and 10-year yields having touched 1.22% in the session (+12bp), later fell back to 1.12% (+2bp). The equivalent Bund yield was eventually left unchanged 0.05% while most other Eurozone bonds were slightly better offered, with Portugal almost alone as the market for its bonds was better bid (10-year now yielding 3.22%, -5bp). That recovery from intra-day higher yields saw equities at close to their lows for the day.

Sole issuer: Unicredit with €1bn deal

Vanilla: Unicredit with a €1bn, 10 year deal

We’re soon going to find out whether the manipulative hand of central bank QE can succeed in fighting market forces. They will want to keep yields anchored into an uncertain (low) growth environment, prepared to tolerate some higher inflation for a while. The market won’t. In the US, September’s industrial production rose 0.1% after a 0.5% decline the month before.

Unicredit was the sole plain vanilla bond issuer with a €1bn, 10-year deal and we recorded a zero session for the non-financial corporate bond market in terms of issuance. Dutch REIT Aroundtown Property was back, but this time with a €500m hybrid issue in PNC6.5 format which will have the yield-wallahs (priced at midswaps+437.5bp) occupied and happy for the BB+ rated deal.

ECB’s weekly corporate bond grab

And so the ECB continued its merry way, and has taken €33.8bn of IG non-financial corporate debt onto its balance sheet since operations began in earnest some 18 weeks ago. Last week’s spree saw the ECB accumulate €1.835bn of debt, down from €2.24bn the week before. We read nothing into the decline in purchases in the week and remain impressed that they can take so many bonds down in such illiquid markets.

The long-term average is still also over €1.8bn per week of purchases and this is some heavy lifting helping to support a corporate bond market where spreads otherwise would likely have been going wider. After all, volatile stocks and rising government bond yields would normally leave corporate bond spreads vulnerable. Not now.

While we have espousing the upside for the corporate bond market all year, we have been grateful for the ECB’s intervention. QE has enabled some excellent performance for corporate bond investors whether they are benchmarked or total return players. Index benchmark spreads (Markit iBoxx) are 30bp tighter YTD for IG credit, while corporate bond returns are sitting north of 5% in the same period.

Corporate risk grinding it out still

Investment grade secondary markets closed out a touch tighter, for choice. As stated above, the ECB is having an impact on valuations and is a major support factor for them. To be precise, index returns are holding at 5.3% YTD. It was the same case for the sterling corporate bond market. Tighter for choice in secondary, returns holding above 11% YTD and no doubt the BoE’s corporate QE also supporting this market, despite a fairly volatile duration market.

The high yield market completed a clean sweep for the corporate bond market in Europe, the Markit iBoxx index a basis point tighter when valuations went in. Returns edged up a little to 7.2% for the year-to-date, and this market has been fairly stable of late. Maybe – finally, we are seeing some support coming from investors crowded out from the IG market.

That’s it; Have a good Tuesday. Back tomorrow.

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.