12th July 2016

Hold on to what you’ve got

MARKET CLOSE:
FTSE 100
6,683, +92
DAX
9,833, +204
S&P 500
2,137, +7
iTraxx Main
75bp, -2bp
iTraxx X-Over Index
333bp, -8bp
10 Yr Bund
-0.17%, +2bp
iBoxx Corp IG
B+145.25bp, -2.5bp 
iBoxx Corp HY Index
B+496bp, +9bp
10 Yr US T-Bond
1.43%, +7bp

Interfering busybodies…

The interfering ECB’s QE actions continue to severely distort market prices such that the bond buying programme is taking in an ever wider of bonds into negative yielding territory. Dutch 10-year sovereign debt bit the dust yesterday, briefly (closed to yield +3bp). France and Austria have only 10bp to go, while heavily indebted Belgium just 15bp. It will be something if soon we are talking in these terms about Spain and Italy! Because we could be, as the universe of eligible bonds declines and crowding out effects – as well as a need for yield (from investors), necessarily pushes investors towards assigning greater allocations to the periphery. That’s market manipulation at its best and it is similarly impacting the corporate bond market too.

At a stretch, the risk free nature of the debt from the likes of Germany, France, the Netherlands and perhaps Belgium offering such low/negative yields could be explained away, but the likely precipitous fall in yields from the highly indebted periphery has to be of concern. We’re not getting into the whole Eurozone longevity/existential debate, rather the issue around what those yields are telling us from a macro perspective. That is, where is the hope if such a low level of return is not eliciting greater levels of spending, consumption and investment and therefore growth?

It is what it is, and we have little choice but to play into it. That’s why we target -0.35% as a yield for the 10-year Bund. The technical drivers which come from the ECB’s involvement allied with the failure for any material upside in economic growth should see us there. We dare say that the likes of French, Austrian and Belgian debt will be in negative territory very soon (in the longer maturities). And it will make a fair chunk of the corporate bond market look even more attractive by comparison, although as we suggested in Monday’s note, there will be much head scratching going on here too, as a not previously thought of risk free asset also offers negative yields – albeit at the moment that is mostly at the front-end of the curve for better rated borrowers.

Returns slip-sliding away

It’s not just the income from – or the number of – government bonds that is falling. The heavy lifting in the opening four weeks of the corporate bond purchase programme is seeing to it that the free float of corporate debt in the market is falling too. And quite dramatically. The squeeze on liquidity has eventually got to result in a more noticeable tightening in secondary. The mechanics of the supply/demand equation will soon enough become much more apparent, and it will result in a significant boost to overall performance through this second half of the year.

So, the ECB reported that in the first 4 weeks of their bond buying operation it had garnered €8.4bn on bonds, and just €1.6bn in the last week of it, representing a slowdown on the previous 3-weeks’ efforts. That could be a sign of the declining liquidity and/or a reluctance from investors to sell. If it is the latter, then a more aggressive bid from the ECB ought to help promote a mark-up in prices (and tighter spreads). This dynamic should feed through into the market as a whole soon enough. Still, €8.4bn is a fantastic effort and represents a good month’s work from the ECB, leaving them on course – if they were to keep the monthly rate of purchases up, of boosting their balance sheet by €100bn. We don’t think they will – or can, sustain the current run rate. The bonds are simply not going to be there.

Market loves certainty

We had the first bit of certainty in the session with the installation of a new UK Prime Minister (due to happen on Wednesday). That got an already buoyant stock market all cock-a-hoop. Equities rallied with the FTSE rising almost 1.5%, the DAX up over 2% and the S&P more than holding on to close at a new record high for the index. Government bond markets took a back seat but only after a morning session in which the 10-year Gilt briefly visited a new record low yield of 0.70% (closed 0.76%, +2bp), while the equivalent Bund ended at 0.17% (+2bp, but with a -0.20% yield earlier in the session).

PepsiCo: €750m in 12-year funding

In credit, the primary market was again very quiet with just a couple of IG deals from PepsiCo and AroundTown Property. The former borrower plumped for €750m in 12-year funding at midswaps+47bp which was priced 13bp inside the initial price talk, while the latter took an increased €500m. That’s a total of just €5.5bn for the month for IG non-financial issuance; Not great.

And into it all, we had the credit spreads tighter and yields on an index basis just a sniff off their record lows. That is, the Markit iBoxx index for IG corporates closed at B+145.25bp (-2.5bp) and the yield on this index at 1.03% versus a record low of 1.02% seen in April last year. We suggested in Monday’s comment that we will get there sooner rather than later, and sooner it will be. The high yield market also managed to feed into the better tone, spreads moved better and yields lower too. The Markit iBoxx index ended the session at B+496bp (-9bp) and the yield at 4.43%. They will both go lower as the summer months progress. Finally, for good measure the iTraxx indices closed better too, although they didn’t quite get carried away given the stellar rise in stocks. Europe Main closed at 75bp (-2bp) and X-Over -6.40 at 333bp (-8bp).

That’s it, 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.