22nd February 2016

My lucky number’s one

FTSE 100
5,950, -22
9,388, -76
S&P 500
1,918, unch
iTraxx Main
113bp, +2bp
iTraxx X-Over Index
445bp, +2bp
10 Yr Bund
0.20%, -2bp
iBoxx Corp IG
B+186.6bp, +0.7bp 
iBoxx Corp HY Index
B+640bp, unch
10 Yr US T-Bond
1.74%, +1bp

Looking after number one… The spiral of contagion – for once – isn’t about the domino effect which comes from falling markets, one collapse leading to another in a different country/region/asset. No, the contagion effect of the moment is negative interest rates and some kind of race down a bottomless pit. Much has been written about the subject and the potential repercussions of a long-term negative interest rate world – and how we might eventually emerge from it. Our view on the developing situation as a means to rid the world of its ills, as we have said many times previously in this daily note: it won’t work. Negative rates are there for a reason – right now because the economic outlook is uncertain at best, or geared up for some kind of calamitous fall at worst. Too much debt, no significant reform, few difficult decisions and a preoccupation with growth – and no one willing to take any pain. Beggar-thy-neighbour policies are seemingly the rage. With that weak and uncertain outlook in mind, why lend? Banks will continue to hoard their cash (it’s the cheapest option). And this leaves the imposition of negative rates as just the latest in a long list of policy tools (playthings) designed to hide politicians’ poor understanding of economics and their unwillingness or inability to implement difficult, long-term reforms (for their own job security and preservation). Many buy into government bonds offering negative yields hoping that returns can be boosted by appreciating bond prices, creating ever lower yields. We hope that eventually everyone realises that the European corporate bond market isn’t a bad place to be. And perhaps even the best place to be. Because we don’t believe economic risks include a cliff-event, the corporate bond market in Europe is no worse than it was, say, 12 or 18 months ago. And we all bought into it then. Admittedly, we have had some single-name event risk (Volkswagen) and some sector risk (Anglo, Glencore etc. on the back of the commodity rout), but by and large, the sell-off in our market has come in the first instance from the contagion impact of the US high yield savaging. EM has come under pressure since, and we’re back to the drawing board as to what impact a slowing global economy will have on all manner of assets (and their prices). As we all readjust, rock solid IG corporate bonds are money good, in our view. We also happen to think most of the IG industrial space is too, as credit quality (as measured by the ability to service obligations) is defensive and corporates are extremely liquid. We still like double-Bs, but can understand the apprehension of adding this higher-beta risk given the impact and correlations on valuations from macro volatility.

Sotfter end to week, but returns improve… There’s just a week to go before we close out the second month of 2016, and for credit market investors, total returns are on the up. Not necessarily because the asset class (spreads) are improving, but more because the underlying continues to rally. Given the above, there is a conservable level of apprehension about equities, and outflows are finding the cash move into safe haven assets – mainly government bonds. The 10-year Bund yield resides at 0.20% again, while the 2-year is at a record low of -0.54%. Peripheral yields have all edged higher. At least corporate bond funds don’t have material outflows, and we believe that we’re unlikely going to see them either once those performance numbers filter through at the end of the month. Higher-beta risk has seen some recovery, while low beta has been propped up by the government bond rally. The Markit iBoxx IG corporate index closed a touch weaker at B+187bp (-4bp in the week), leaving returns YTD at +0.25%. In HY, the index closed unchanged in the session (-28bp in the week) and returns YTD are at -2.5%. In the iTraxx synthetics, Main was 2bp weaker at 113bp as was X-Over, left at 445bp. CoCos had the best week, with index yields dropping some 150bp to 8% (see chart) and the likes of Deutsche’s 6% AT1 rebounding 7 points. However, any big move higher from here in price might be a little more testing.

CoCo Yield Drops As Mood Brightens

Earnings season coming to a close, more issuance please… The earnings season is coming to a close and with it the blackout period, so we can hope that issuance picks up. It’s important that is does, because it usually brings confidence to markets, even if we do get some – usually modest – secondary repricing. We need that now, given the directionless secondary market – although it has largely been inactive, held hostage to illiquidity and macro volatility. We had a decent week for issuance when set against the drought before it, but it is still at extremely low levels over all. We can easily absorb much much more. We had a fairly consistent daily supply of deals from senior financials, taking the total for 2016 to around €21bn, while for non- financials we jumped to €19.5bn YTD thanks to a €6bn boost from Honeywell and Amgen. HY issuance is stuck at just €1.4bn and is unlikely to pick up significantly until we see some broad macro stability, improved sentiment and some tightening up in spreads. Elsewhere, US stocks closed unchanged into a particularly strong CPI print (2.2% annualised) which will have raised a few eyebrows, while this week we have US manufacturing and services PMIs to look forward to. In Europe, well, all eyes are on the Brexit debate, with the referendum due June 23.

Have a good day, back tomorrow morning.

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.