10th February 2019

It was just too good a thing

MARKET CLOSE:
iTraxx Main

74.2bp, +1.2bp

iTraxx X-Over

319.9bp, +2.5bp

🇩🇪 10 Yr Bund

0.09%, -3bp

iBoxx Corp IG

B+155.7bp, +2bp

iBoxx Corp HY

B+491bp, +6bp

🇺🇸 10 Yr US T-Bond

2.63%, -2bp

🇬🇧 FTSE 100 6185.62, (-1.55%) 🇩🇪 DAX 12901.34, (-0.71%) 🇺🇸 S&P 500 3372.85, (+0.12%)

Squeaky bum time, again…

Approaching the half way point for the month and we find that credit spreads have performed better than even the most bullish of expectations. OK, there are still almost 11 months to go and the macro risks are building, but we have some good performance in the bag to help alleviate some of the inevitable weakness and/or pain to come. The situation is complex for us as we need to consider a number of factors. Macro weakness can be a concern from the impact it might eventually have on corporate fundamentals. However, we forgive some weakness because the subsequent low rate regime entices us to add corporate credit risk for the yield pick up sorely needed in order to generate performance. That push-me-pull-you like technical/fundamental dynamic works a treat while equities don’t show much weakness. As soon as equities tank (like they did last Thursday), then credit inevitably weakens.

And that is just how it worked out last week. Those more difficult sessions as we closed the week saw the first 2-day reversal in spread tightening for a month. The Dax lost over 1% in those final two sessions, for example, and IG spreads (iBoxx index) widened by 3.5bp. There’s no panic in credit –  far from it. But just like the final quarter of last year when we saw some extreme weakness in equities, credit had little choice but to follow. We will again, if it plays out that way.

In a flash, though, one could argue that we are now seeing the markets react to the incoming news flow how they should and how we always feared. With weakness. After all, there is no clarity regarding the US/China trade talks, the IMF and the EU Commission have downgraded global/EU growth forecasts, respectively, manufacturing across the Eurozone is showing a sustained contraction of late and is probably in recession, while the service sector doesn’t seem to be too far behind.

It’s almost as if January’s strength which carried on for the early part of February was just too good to continue.

The 10-year Bund yield is at 0.09% (gulp, -3bp on Friday) and the lowest level since Q3 2016 – and is now just 23bp away from reaching a new record low yield (previously -0.13%). And the ECB is not in assistance, yet. The news flow on macro has been a like a steady drip feed, but it has mostly been highlighting what we already knew – that the Eurozone is in deep trouble and isn’t going to turn around anytime soon, especially as the German industrial sector will continue to feel the chill of that slowdown in China.

In a sense, we know what’s coming. There seems to be little upside to risk assets. The Dax was up over 6% this year a week ago, it is now up 3.2% and the direction of travel seems to be lower for equities. Credit spreads probably have enough in the bag to see out some weakness in equities which might take them another 4-5% lower before we then widen back to where we started the year. But total return investors will be showing positive returns (currently +1.9% IG) as the underlying would stay well bid.


Corporate primary outlook uncertain

Non-financial IG credit corporate primary has seen just three deals this month so far for €2.3bn. We have Altria to come supposedly this week, and that will likely add another €2bn or so to that total. However, there is no doubting that primary is not firing on all cylinders and those borrowers with plans to come soon but didn’t pull the trigger on a deal might be forced to wait longer now. We had a decent January but investors have plenty of cash to put to work still.

The 2019 total so far for non-financial issuance in IG comes to €29.2bn which is a decent enough return, but the high yield market issuance languishes at just €3bn. Having got used to issuance exceeding €45bn per year over the last few years (€75bn in 2017, €62bn last year), it will be some achievement to get anywhere close to that this year.


Weakness through all risk markets

Poor macro data is now beginning to have an impact on risk assets as that early year euphoria – or rather hope that a material downturn might be avoided – fades, almost dramatically. In a way, it’s beginning to feel like Q4 2018 all over again. We closed last week with the Dax again off by over 1% in the final session and most European markets were not too far behind, while the S&P managed to recover to get over the line flat.

The last thing the Eurozone needs is a No Deal Brexit

Rates, though, are where the current action really is. That 10-year Bund yield has dropped to below 0.10% as mentioned earlier, and 0% is looking like the next stop. However, the message in it is clear. The Eurozone is heading for – or is already in – recession. The incoming data is going to be poor for a while. And the ECB will soon be forced to accommodate. The last thing the region needs is a no-deal Brexit.

For the week ahead, we have another visit to Beijing by US trade officials with markets nervous about reaching some kind of agreement between the two countries ahead of the March 1 (truce) deadline. US Treasuries have been better bid into it, the 10-year yield back down to 2.63% (-2bp Friday).

A new LTRO facility will be the first course of action. New QE likely isn’t going to be necessary yet if the market can keep yields at these depressed levels. However, we need to be watchful of those Italian yields as the 10-year benchmark heads back to 3% (currently at 2.97%) and the BTP-Bund spread moves higher again.

In the secondary market, we had some weakness as mentioned above and the IG iBoxx cash index ended the session at B+155.7bp (+2bp), but was still 4bp tighter for the week and is 17bp tighter this year so far. The edginess was clear through all the cash market amid little flow and light volume, with the CoCo index also wider – by 8bp to B+632bp (+9bp for the week). The high yield index closed 7bp wider at B+491bp which was just 2.7bp wider for the week.

As for this week, the trade talks might dominate but we do have plenty on the earnings front to look at including reports from the likes of Coca-Cola, Pepsi, Kraft Heinz, Deere & Co, Michelin and Nissan all due.

A much-needed holiday takes this daily comment out of the firing line for the next 2 weeks, although GJ Prasad will still be posting his banking sector views. Have a good day.


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.