9th May 2016

May the force be with you

MARKET CLOSE:
FTSE 100
6,126, +8
DAX
9,870, +18
S&P 500
2,057, +7
iTraxx Main
80bp, +1bp
iTraxx X-Over Index
339bp, +9bp
10 Yr Bund
0.14%, -2bp
iBoxx Corp IG
B+142.5bp, +1bp 
iBoxx Corp HY Index
B+497.9bp, +4.5bp
10 Yr US T-Bond
1.78%, +3bp

We never really moved off square one…

That weak non-farms report coupled with increasingly mixed economic data highlight that little real progress has been made in trying to get the US – and global – economies back on a sustainable, sure-footed growth trajectory. There will be no US rate hike in June. The data will stay mixed, the Brexit referendum may inject some volatility into global markets, but cheap liquidity will be the glue that continues to hold everything together. And so we have a couple of months of clear daylight in which to bask some more in this low-rate environment before we fret again about a possible US rate hike.

That means equities might be propped up by the prospect of continued cheap liquidity, but under pressure from weak growth dynamics, event risk and volatile oil. Government bond yields are anchored or going lower into the negative mood. Corporate bond spreads, yields and returns are going lower too. They offer a more enticing pick-up versus government bonds, with supportive metrics and very low default rates. How can it be any different anyway, given we have the ECB joining the show in the not too distant future?

The above should be some kind of nirvana for borrowers – with better funding costs to come. They are already fantastic on a historical relative basis and we believe will stay that way through the whole of this year, at minimum. Borrowers should not, therefore, feel the need to rush to the markets. There will no doubt be a stampede next week! Biding one’s time unless cash is needed in the normal course of “general corporate purposes” funding because the market will remain so receptive is a good technical support dynamic to have. The pressure is off.

As for the markets overall, it’s almost a wonder we rallied in the first place after feeling fairly morose through January and February. Positions might have been massively oversold back then and too much emphasis was given to oil being the driver for the bear market, but little has changed to suggest the recovery through March and April was warranted and/or ought to be durable. The US looks like it is running on empty – but doing it well. The eurozone is still stuck in the lowest of gears and has needed more stimulus, which is unlikely to do the job it was intended for. The news flow around China may suggest they have managed to stabilise growth in the 6.5-7% area, but there are other warning signs flashing on the country’s high levels of corporate indebtedness.

Credit, spreads, returns and yields

Three’s up. That is, total returns for IG credit as measured by the Markit iBoxx corporate bond index are up at a stunning 3.0% for 2016. That can all be lost before the year is out, but 3% in this ultra-low yielding environment with little of the volatility seen elsewhere is incredible. Though understandable given the aforementioned comments. Spreads closed last week a little under pressure, but the rally in the underlying continues to prop up returns. If that Bund holds firm into year-end (we think it will), then returns for IG credit can see 4%. What’s more, the index yield continues to grind lower, down at 1.28% and another low for 2016/12-month low too (1.02% being the record low). We’re still thinking that the record low index yield level set in March 2015 is under threat.

The shorter duration HY market is returning more YTD, but there was no runaway push higher into the close last week as the front end of the government bond market underperformed. Still, the HY market is in good shape, even if spreads and index yields were 15-20bp wider on the week. There is a greater correlation here to equities, and secondary market liquidity is worse than in the IG market. The iTraxx indices were higher as the cost of protection came under some pressure into the weaker tone, and levels at their new contract highs. Main closed at 80bp and X-Over at 339bp. Cash credit is outperforming.

The week ahead

As expected, this week for corporate bond markets will again be defined by the amount of issuance we might get. The fun and games syndicate desks continue to get away with – high IPTs followed by a ratchet tighter – will be with us, but we’re going to be looking more at the issuers, the amount of issuance and performance on the break. The latter has been good (the latest Daimler deals being an exception, see previous comments), but we could easily absorb €10bn+ of supply where borrowers are not of the frequent kind – and just revisiting the markets. Still, we took down €7bn last week in what was effectively two sessions, with over €1bn in HY but nothing in senior financials. The European earnings season is also hotting up, and that might be an excuse for some to stay sidelined as they enter their blackout period.

Other news saw that Chinese exports (-1.8%) and imports (-10.9%) both fell by much more than expected in April suggesting a slowdown domestically and a still difficult international environment. Exports to the US particularly stood out as they dropped by almost 10%, while those to the EU showed a pick-up. This week, the news flow on macro is light, with just some consumer data (retail sales, sentiment) and producer prices from the US while the earnings season there is wrapping up. So hopefully calmer climes will leave us in better shape in all markets.

Have a good start to the 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.