23rd August 2016

Memories

MARKET CLOSE:
FTSE 100
6,829, -30
DAX
10,494, -50
S&P 500
2,182, -1
iTraxx Main
70bp
iTraxx X-Over Index
316bp
10 Yr Bund
-0.09%, -5.5bp
iBoxx Corp IG
B+121.6bp, +0.5bp 
iBoxx Corp HY Index
B+429bp, +3bp
10 Yr US T-Bond
1.54%, -4bp

Not blaming it on the Brexit now, are they?…

We’re into the peak of the holiday season and it is a job well done so far. Government bond prices are holding firm (yields only edging off record lows), equities have had a super run and are mostly in the black YTD – with the hitherto beleaguered DAX not far off, while corporate bonds have been the pick of the bunch on valuations/returns buoyed by central bank QE activity. And oil has also had a good time of it of late with Brent recovering to around $50 per barrel.

Oil on the rise

Oil: Well poised

The rising tide has indeed lifted all boats. The macro news flow has been very mixed and we would admit slightly better than expected generally, but we’re still failing to break out of the doldrums in any confident and sustainable manner. September’s ECB/Fed meetings loom and we do not expect any action on interest rates from either, although the ECB might be thinking about adding to and/or extending its QE beyond March next year. There have been some voices in the Fed suggesting a September rate hike and futures markets ascribe a near 50% probability of one coming, but we think they will hold back.

There have been snippets of supply, but it has mostly been in sterling. Non-financial issuance has seen the likes of BMW, BP, Vodafone, Places for People and Intercontinental Hotels lift some cheap pounds while the banks have also been printing – although some of that has been just a bunch of small taps. That’s still a high level of issuance in a short period of time – for the sterling market. However, it is too early to think there will be plenty more where that came from. The BoE will be hoping it is though. The euro-denominated market has been quiet of late with just €4bn issued in non-financials this month so far, and nothing was done in the last week or so. We would think little will get printed this week (and into a long weekend in the UK), but when we kick-off September proper, the markets will be anticipating a slew of issuance.

Sterling corporates off the boil, euro still beating a drum

The euro-denominated corporate bond market continues to see enough ECB demand to keep tightening and spreads now reside at the tightest level of 2016, the Markit iBoxx IG corporate index at B+121bp and the index yield up slightly off the lows at 0.84%. We are targeting a 0.70% index yield level by year-end. Total returns are anchored at around 5.7%. We can expect this trend to continue way past year-end as the ECB’s lifting as well as returning supply boosting confidence (September onwards) will keep the corporate market well-bid. As a reminder, we are looking for a sub-100bp level for the index by year-end (the record low being B+94bp).

The sterling corporate bond market rally has stalled though. Actually, it has reversed a little, with spreads on an index basis giving back a couple of basis points – or more – over the past week. Index yields have also backed up to 2.38% from a record low of 2.27% just over a week ago, following the euphoria of the BoE’s QE announcement. We do believe that spreads will resume a modest tightening trend, but index yields ought to drop again once Gilt yields resume their own decline through the next several months. Additional BoE action (on rates or otherwise) is also to be expected – if not in Q4, then Q1 2017.

As for HY, spreads and yields as measured by the Markit iBoxx HY corporate bond index are at their year lows. Spreads sit at around their recent tights at B+429bp and the index yield at 3.83%. That is around the tightest – in spread terms, that HY has been since July 2015 while the index yield is the lowest since April last year. We’re probably seeing the dual impact of rising oil prices (US HY confidence returning) and the ECB’s IG activity having a positive affect on the HY market. Again, we think that there is much more to go with compression between high and low beta credit more driven for the foreseeable future by the crowding-out impact of the ECB interest IG markets, and subsequently the increasingly desperate search for yield by investors.

In addition, that compression is seen in flatter issuer curves, but we are also seeing it occur between IG and HY. The better tone in the high yield market is seeing greater spread tightening and therefore the compression with low beta IG markets. That should continue so long as the macro tone towards risk assets remains supportive.

ECB’s heavy lifting resumes, the crunch is to come

That ECB’s shopping receipt showed that €1.6bn of IG non-financial corporate bonds were accumulated last week, or €17.8bn in the ten weeks since the corporate bond QE operation began. That is an increase on last week’s €1.25bn – and admittedly, somewhat of a surprise into the biggest holiday week of the year. So, a sterling effort by the Eurozone’s central banks! The weekly average sits at €1.78bn. The ECB is certainly declaring its hand and making its intentions clear.

heavy liftingWe think that spreads will continue to react to the heavy lifting – and there is likely at some stage going to be a crunch tighter rather than the more short incremental tightening we are witnessing at present. Illiquid markets with such an amount being taken out of them by the central bank ought to see spreads much tighter than they are now. That might come into September when the markets return to normal and investors find there is a scarcity of bonds in which to get their cash invested in.

There’s little to be garnered more generally from how the markets have been trading last week and how they might trade before the end of the month. Activity levels are extremely low and exaggerated movements in prices are likely on the back of the poorest of secondary market liquidity. In the session yesterday, for example, 10-year Gilt yields fell almost 6bp to 0.56% (although the news that the latest auction went well might have been an influence), while the equivalent Bund yield dropped 5.5bp to -0.09%.

Yields fell across the board with even the US 10-year Treasury down at 1.54% (-4bp). Stocks were generally in the red, but by a very small amount in lacklustre holiday trading. As mentioned earlier, Brent is nicely poised around the $50 per barrel area.

Have a good week, we will be back next Tuesday and resume our daily format.

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.