16th May 2017

Mine’s a triple

FTSE 100
7,456, +20
12,803, +33
S&P 500
2,402, +11
iTraxx Main
62.4bp, -0.4bp
iTraxx X-Over Index
253.0bp, -4.7bp
10 Yr Bund
0.42%, +3bp
iBoxx Corp IG
B+115bp, unchanged 
iBoxx Corp HY Index
B+319.2bp, -0.3bp
10 Yr US T-Bond
2.34%, +1bp

What about investment grade?

We know that high yield spreads are at record tights, as measured by the Markit iBoxx HY cash index – and our view is that they will go tighter still, perhaps quite significantly (see Monday’s comment). But what about investment grade markets?

Using the same index measure, we’re 21bp away from the most recent lows seen back in Q1/2015. The technicals in this market ought to have been much more supportive for a tightening trend, but we have strangely underperformed the high yield market by some margin. The tightening this year has been just 19bp with the index at B+115bp, and apart from a post-Macron burst it has been very laboured.

The technical support has come from the ECB’s QE programme where the central bank has lifted almost 15% of the eligible market in an €85bn bond grab in just under a year (more on this later) – or €1.7bn of corporate bond debt on average per week. There has been no rotation out of credit into equities as some might have feared on improving growth dynamics and a switch from capital preservation to capital appreciation investor strategies.

Improving macro effects

The improving macro picture might have elicited a switch in strategy, but it has also sustained (and perhaps helped) fundamentals with improvement in the credit metrics of borrowers. The default rate has thus remained extremely low (less than 2%) and confidence in the asset class maintained. Refinancing risks – rather costs – have been low or at record lows for many borrowers for as long as we can remember. And they don’t look like rising much anytime soon.

Rate markets thus have also been supportive, with yields staying at very low levels with ECB policy accommodation set to remain unchanged through the rest of 2017. We’ve sailed through Brexit, Trump, the French elections and fears over escalating geopolitical risks and tensions (Syria, Russia, North Korea). The recent German election news flow suggests that it will be business as usual there.

The ECB, in our view, has also failed to stir the corporate sector into printing more, for reinvestment in the real economy. Or just to print more because funding costs are so low. The average level of gross supply over the past 4 years has been stuck in €250 – €290bn range and the post-ECB QE issuance levels haven’t picked up – at all!

Secondary market liquidity has been as poor as it has ever been (except for the ECB). Investors have mainly added through primary, rather than chase the market in secondary. Overall though, the market is set up to record a more meaningful tightening trend than what we have seen these past few months. It doesn’t mean that it will.

We are, however, of the view that spreads will continue to tighten, but the record low-level on the index is out of reach – this year anyway (B+94bp). The ECB is already likely priced in and we need a catalyst to catapult us tighter (or wider). The index spread level has already exceeded our original target that we set out this year, but at B+115bp, we should be looking in terms of a grind tighter to a B+100-105bp context by year-end.

Three is the magic number

Where to start? It was a good day in primary with just about something for everybody on the screens. In the investment grade market, we had a non-financial 3-tranche offering from Germany’s E.ON which printed €2bn split between 4, 7 and 12-year tranches with final pricing just 3-5bp inside the initial guidance.

In euro-denominated high yield, CNH issued a 7-year at midswaps+130bp, taking €500m but managed to reduce the cost of funding by 25bp versus the opening gambit. In financials, higher beta offerings were the order of the day with a €1.25bn AT1 PNC6 deal from Unicredit to yield 6.625%, while Swedbank issued a T2 transaction for €650m.

Sterling markets also had a bright session as AB InBev took £2.25bn also in a 3-tranche effort in 8, 12 and 20-year maturities – and managed to take between 8-15bp off the initial pricing (which is unusually high for this market) – but it was on a combined book approaching £6bn.

ECB weekly corporate bond purchases

The latest ECB investment grade, non-financial corporate bond purchases came in at €1,515m. After the two previous weeks averaged just €1,180m, we’re back on the up (see chart, below). We had been thinking that the reduction in the size of the overall bond purchase programme by 25% from €80bn to €60bn of purchases per month might have been having a material impact on the corporate bond grab-fest.

It may well be, but the higher accumulation last week is a potentially good sign for secondary market valuations. At least in terms of keeping them propped up at these tighter levels.

ECB weekly purchases rise

The total purchases to date, after 49 weeks, stand at €84,929m, with the long-term weekly average of purchases at €1,733m.

Otherwise, a cautious tone to start the week

Equity markets finally ended the session in the black amid little news flow with intraday record highs being set on some bourses (even the FTSE). In the US, the S&P finally closed above 2,400 – at 2,402 (+11). Rate markets were a touch better offered and yields rose into it. The 10-year Bund yield backed up to 0.42% (+3bp) and the spread with OATs remained at 46bp, the latter not moving after Macron appointed his Prime Minister. Gilts underperformed, the 10-year Gilt yield 5bp higher at 1.14%.

The secondary IG corporate bond market closed unchanged amid focus on primary. Sterling market investors might have scrambling to get their fill of AB Inbev debt, but the secondary market managed to trade a touch higher, the index spread declining 0.5bp to G+140.7bp – and to the lowest level since early 2015.

In high yield, the picture was the same, with the market unchanged, the index left at B+319.2bp. And finally, the synthetic indices move a little better with Main at 62.4bp (-0.4bp) and X-Over down at 253bp (-4.7bp).

Have a good day.

For the latest on corporate bonds from financial news sources, click here.

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.