14th March 2016

It’s a mad, mad world

MARKET CLOSE:
FTSE 100
6,140, +103
DAX
9,831, +333
S&P 500
2,022, +33
iTraxx Main
68bp, -16bp
iTraxx X-Over Index
313bp, -45bp
10 Yr Bund
0.27%, -4bp
iBoxx Corp IG
B+160bp, -10bp 
iBoxx Corp HY Index
B+546bp, -26bp
10 Yr US T-Bond
1.98%, +5bp

Japanification of the corporate bond market, again… We said last week that we believed the ECB would not be participating in the primary non-financial corporate bond market. Our view is that the ECB is lifting covered bonds in primary as a means to finance the banking sector by creating another liquidity transmission mechanism route for it. We believe that this will not be the case for the corporate bond sector (full details of the programme not yet released). Remember, the BoE did not participate in the primary market when it was buying corporate bonds. Amongst other things, this would cause massive distortion to the primary corporate bond market (it will anyway, we suppose). The idea for the ECB’s participation is to further reduce financing costs for the whole corporate sector through a push-down effect. That is, it will participate when it can by adding through the secondary market, and force investors – looking for assets and yield – down the credit curve. The compression between high and low beta spreads will return. How much will it buy – or could it buy – each month, what names and ratings, and who will do the credit work? Will it buy VW debt, can it buy corporate hybrids, insurance company debt and beaten-up commodity sector paper? These are the details that will need to be fleshed out, and the market will await them. In the meantime, and even after they are known, we have a marginal buyer with the deepest pockets of all. All roads lead to a tightening in spreads everywhere. High-yield corporates (not included in the asset purchases) will seize their opportunity, and refinancing of their upcoming redemptions will become easier – and cheaper. The wall of funding maturities in 2017/18 ought to be pushed out further (2020 onwards) and the default rate should stay low even though economic growth will barely rise. Investor risk tolerance will increase, disintermediation of corporate funding expand and finally, we may be approaching the moment of truth for the European corporate bond market. That is, a true Japanification of it as the ECB attempts to “dumb it all down to zero”.

The last throw, almost… This move by the ECB is a real game-changer and totally unprecedented for the euro-denominated corporate debt market. The net effect will be for materially tighter spreads in secondary, lower turnover and volume flows, even fewer relative value trades – thus reduced secondary trading – and higher new issue premiums in primary eventually, once the mad scramble to get cash positions filled has played out its course. All borrowers should benefit, not just those in the eurozone that might be of interest to – or on – the ECB’s shopping list. With rates and yields going higher in the US, there will be a funding advantage (swaps permitting) for US borrowers to hunker down over here, and it will be reasonable to expect a sustained higher level of US-domiciled entities to look at funding in euros.

Junkies, fixes and cold turkeys… The markets called its bluff. The ECB has effectively only a little left in its armoury to “save” the eurozone now, should it need to try again – or add some more. Dramatic and harsh, but fair. We will now all have to tough it out for the next few months because the data will stay fairly poor, but heading into third quarter we will need to see the signs that this huge easing is having an impact. That means the oil which has lubricated this transmission mechanism needs to see loan growth increase, inflation stabilise (or at least no longer decline), growth show signs of a pickup, unemployment fall further and investment pick up. If we see signs that the eurozone economy remains in the doldrums, then we would expect Draghi to look at further easing (he suggested he would) and perhaps a further addition to the asset purchase programme. Thereafter, the eurozone junkie will not know where the next fix is coming from. Unfortunately, there is a greater probability of events playing out this way than there is of politicians enacting the structural reforms needed to achieve sustainability in longer-term economic growth. After all, reforms cost votes, popularity, jobs – and take time, of which we have precious little.

Spreads tighten and yields plummet

Monday Chart 14th March 2016 creditmarketdaily copy

Corporate risk biggest medium term gainer… The ECB will be delighted with its day’s work. It gave the market what it wanted and after some initial reservations, we have all bought into it. In the corporate bond market, we had the hugest of squeezes as we closed out last week. IG spreads crunched better, leaving the Markit iBoxx index recording one of the best gains ever seen as the index level for IG corporates dropped to B+160bp, or 10bp in the session (see chart). That is the lowest level since the opening week of the year, and now just 6bp wider YTD. The yield on the index fell to 1.53% (-13bp) – the lowest since June last year. At the high beta end of the market, the CoCo index yield fell to 6.66% (-72bp), while the spread crunched 70bp tighter to B+695bp, recovering much of the performance lost in January and February. We always said a catalyst was needed for prices to recover in this sector, and the ECB was it. The Deutsche 6% CoCo was up at around €87 (cash price), around 5-6 points higher in the session and 17 points off its low print earlier this year. That follow-through was seen in other subordinated sectors too, for example corporate hybrids. The lift-fest saw to it that prices rose sharply, leaving the index 43bp tighter at B+426bp. These are all stellar recoveries, and new deals now make economical sense for borrowers. We might just see a few emerge. The high yield market was also marked better and the Markit iBoxx HY corporate index 26bp lower at B+546bp as prices improved, rounding off a super day for performance in the corporate bond market. Returns YTD for HY are now a positive 0.85%, having been negative up until the session prior to Friday’s close. In IG, total returns have been positive all year and the sector is now up 1.5% YTD. Elsewhere, peripheral risk was a clear winner. In synthetic credit, the iTraxx levels dropped to their lowest levels of 2016, with Main at 68bp (-16bp) and X-Over at 313bp (-45bp). Bund yields moved 3-4bp lower in intermediate and long maturities, while BTP and Bono yields plunged. The Italian 10-year fell 13bp to 1.32% and the equivalent Bono yield to 1.48% (-10bp).

Supply: Will the sluice gates open?… Now there’s a $64,000 question if ever we saw one. Intuitively, we have to say yes. Syndicates will be chomping at the bit to save their first quarter and rush issuers to get some funding in this week and next. Spreads tighter, yields lower, all-in costs declining and demand huge, with sentiment on the up and little to upset the markets for the moment. They will point to Friday’s deals from APMoeller and Valeo, which lifted a combined €2.1bn on books exceeding €13bn. But wait. There’s no need to rush. The ECB has made its intentions clear and the corporate bond markets will stay better bid come what may (almost). The backstop bid by the biggest player in town with infinitely deep pockets means that funding costs will stay low, “forever” and for everyone. For corporates, each basis point matters for their shareholders and for reasons of bravado versus peer groups. And in this sense, those funding costs will be better in Q2, and likely in Q3 as well. Time, as the saying goes, is money. Wait if you can. Anyway, the IG non-financial supply for the month to date stands at €18bn, and according to data supplied by Dealogic, we’re up at €49bn YTD, which compares unfavourably to the €80bn for the same period last year. In HY, we have been graced with less than €2.5bn, and while IG could easily see €15-20bn printed before the month is out, we would expect HY issuance to remain fairly subdued.

We believe you will have a good week. 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.