7th July 2019

Liquidity aplenty, but expensive to hold

MARKET CLOSE:
iTraxx Main

50.2bp, +1.4bp

iTraxx X-Over

243.5bp, +6.7bp

🇩🇪 10 Yr Bund

-0.36%, +4bp

iBoxx Corp IG

B+119bp, -1bp

iBoxx Corp HY

B+399bp, -2bp

🇺🇸 10 Yr US T-Bond

2.03%, +8bp

🇬🇧 FTSE 100

7356.42, -29.00
🇩🇪 DAX

12457.70, -0.10
🇺🇸 S&P 500

3006.79, +1.03

… and greater risks emerging

Until the late pull back when markets were undermined by the minutiae of the timing of any Fed rate cut, it was looking fantastic. Actually, we don’t think it changes much and it is looking very good still. We’re in the midst of the mightiest bond grabfest in history. We have record low bond yields. Corporate funding costs are collapsing. The S&P500 was almost at 3,000 (and up almost 20% this year) is no mean feat, either. It’s record-breaking territory almost everywhere one looks. All that is left is for corporate bond spreads to tighten – a lot – to join the record breakers club. It’s a euphoric time but declining yields/rate cuts/injection of liquidity into markets are no panacea for macro recovery.

Easier monetary policy now just props up asset markets and inflates any bubbles some more. But, given where macro is today, it will not likely stop recession in the Eurozone and likely the US, nor will it promote greater corporate investment. The trade tensions between the US and China (and Europe) are added to the political risks emerging from Hong Kong (and the UK), while a host of new appointees at the EU commission have their work cut out on the multitude of issues facing the region.

-0.50% is just a matter of time. We have long forecast that level for the 10-year Bund yield and actually believe -0.75% is very much likely (currently -0.36%, low -0.41%). We have previously made the point that these safe-haven government bonds should no longer be viewed as being interest-bearing instruments. If investors believe that the price is going up, they buy. The yield is simply a mathematic formula. The trade? Go long what Christine Lagarde might represent. A shoo-in for the role to be vacated by Draghi courtesy of political shenanigans behind the scenes at the EU, this consummate of politicians will be pragmatic and certainly will not want to be responsible for any further avoidable ‘crisis’ on her watch.

Whatever her questionable record as French finance minister and as head of the IMF, the ECB will not be taking any chances and we can expect a continuation – if not some more, and quickly – in terms of dovish monetary policy. It’s just easier. The needed structural reform at the government level across the disparate nations which comprise the Eurozone’s economy is not coming as it would be too painful and a vote loser.

Anyway, the markets reacted immediately last week and those yields plummeted. Focus is always on the Bund curve (negative yield for much of last week all the way out to 20-years) and other safe havens (France 10-year yield accelerating lower but off last week’s low of -0.13%), but it is worth looking further afield.

BTPs offer a 1.74% yield now (against last week’s low of 1.56%), and still the lowest level since October 2016. Spanish paper, less than a decade ago yielding close to 7% in the 10-year as the Eurozone crisis peaked, still looks like becoming the first peripheral government benchmark in this maturity to go negative yield (now at 0.33%, versus a low last week of 0.21%).

The net result is that investors are going to be forced to buy more esoteric bonds as they hunt for yield. Some liquid investments are just too expensive and that need for yield make liquidity considerations a secondary factor in the investment decision. That will quite possibly store up problems as we have seen with several panic fund withdrawals of late, but that is for another time.

Right now, there is little choice and it is all about incremental performance. In credit, that performance is going to be excellent and borrowers are going to fund at their lowest ever levels. With the so-called ‘wall of funding’ also less of an issue for high yield markets, it is broad macro weakness which is eventually going to be the high yield market’s problem, although for now – and it has been the case since 2009 – the default rate has been contained. In fact, it has barely risen above even 2.5% in any period since then. It’s less than 1% in Europe now.

So buy, hold, clip the coupon and move on to the next issue. It has served credit investors well for the past decade. IG spreads are at their tightest level this year (iBoxx index), AT1 market spreads are at their tightest level for a year (returns up at 11.3%) and the high yield market somewhere in between and catching up rapidly in spread and total return terms.


Primary to start winding down

We had a surprisingly decent week in primary with deals right through it. In IG non-financials, Merck KGaA opened business with a triple-tranche €2bn offering, while Deutsche Telekom took €2.1bn in a dual tranche transaction. €5.9bn was printed in the week. Senior financial issuance came in at €3.5bn and included the return of Italy’s beleaguered Monte Dei Paschi (€500m). The high yield market drew a blank.

From now, we would think that the bulk of July’s remaining business in primary will be done this week – but may extend into the middle of next week, before markets close for the summer. In that sense, we think €5bn – €10bn of IG non-financial issuance is possible in this period, up to €5bn of senior deals and we expect something to emerge from the high yield market. The latter has drawn a blank so far this month.

The €172bn of IG non-financial issuance year to date is a record run rate, and should the markets continue to play ball – and it looks as if they will (lower rates, more money flowing into credit, high levels of demand, low’ish levels of event risk), then we could be challenging that €289bn record of 2009.


Markets pull back after heady payrolls

So the big focus as those yields headed lower was on Friday’s non-farm payroll report. We had some respite from the sense of doom. The US jobs market bounced back in June after a poorer May, with 224,000 jobs added (revised lower to 72k in May). The unemployment rate edged higher to 3.7% from 3.6% and average wage growth was unchanged at 3.1% year on year.

On the back of it, we saw a significant reversal in safe-haven government bonds while equities also gave up 0.5% or more. The view that the Fed might not cut at the July 30-31 meeting, or maybe only twice this year (instead of three times) was the reason for the pull back. The 10-year Treasury yield rose a massive 8bp to 2.03%, the Bund yield rose 4bp to -0.36% as did the 10-year OAT yield (-0.08%). The Gilt in the same maturity also recoiled, the yield on the 10-year rising to 0.75% at the close (+7bp).

Credit index also gave a some back. but was still outperforming. iTraxx Main closed at 50.2bp (+1.4bp) and X-Over rose by 6.7bp to 243.5bp.

In cash, the market is a little more technical and only at risk of widening spreads if equities fall particularly sharply. Few will be selling given the inability or difficulty of getting paper back at a reasonable level given the poor levels of secondary market liquidity.

We edged a little tighter in last week’s final session with the IG iBoxx index closing at a 2019 tight of B+119bp (-1bp) and 6bp tighter in the week. Similarly, the CoCo market was better bid for choice on Friday, and at B+487bp was 37bp tighter in the week.

That trend was reflected also in the high yield market, with spreads touch tighter and there index at B+399bp gained 17bp in the week.

As for the week ahead, it is a quieter one on the data front (US inflation, European industrial production, Chinese trade) and we have various Fed officials commenting on the economic outlook. That leaves a fairly uninterrupted week for borrowers to get deals away ahead of the summer break which will curtail the higher levels of interest thereafter.

We are taking our own break now and with the market slowing down, we will be publishing more sporadically over the summer weeks.

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.

%d bloggers like this: