26th October 2015

Which Bond(s) do you want?

MARKET CLOSE:
FTSE 100
6,444, +68
DAX
10,795, +303
S&P 500
2,075, +23
iTraxx Main
74bp, -4bp
iTraxx X-Over Index
293bp, -20bp
10 Yr Bund
0.51%
iBoxx Corp IG
B+157.3bp, -2.5bp 
iBoxx Corp HY Index
B+497.8bp, -10bp
10 Yr US T-Bond
2.09%

Lights, camera, action… The scene is set and the most important actor is about to enter the stage. That’s Janet Yellen of the US Federal Reserve. If she plays her lines out to perfection – as we expect – we will rally into year-end while left with a cliffhanger of a wait until the December FOMC episode. What do we want? No change, the mystery to drag on longer, and not to be put out of our misery. After all, Draghi delivered his lines with gusto and purpose and it is clear where the ECB stands. The audience loved it. The Chinese have done their part with a 25bp rate cut as well as a reduction in the bank reserve ratio. The market went delirious. The global liquidity floodgates have opened further and the central banks are pushing on that string to keep ‘it’ all ticking over. That’s the good news keeping the ugly at bay, and we should trade into it and take on risk. Unfortunately, in the long term it’s a losing battle. Only structural reform in Europe, a prolonged and necessary slowdown in China and a reduction in indebtedness everywhere will right the wrongs of past excesses. That’s hardship and pain no one really wishes to take. We’re entering unchartered waters on the macro policy front, but here’s hoping monetary policy can keep risk assets afloat for a good while longer.

Red hot Friday begets a red hot week… Finally! We’re getting somewhere now. We closed out last week squarely on the front foot. The market was very strong. The new Generali subordinated deal was up 3.5 points versus reoffer in under a week at Eur103.25 bid, as basically the market went into bid-only mode. This is worth mentioning because it is the latest big deal that matters, is liquid and something of a bellwether deal. Even Glencore paper was bid-only. Primary will open soon enough if not today (Monday), and new issue premiums will be more acceptable for borrowers. And it all works for corporate bonds Q1’esque-like because you get nothing for holding cash, in fact you pay for the privilege of holding cash. Bund yields are negative out to 6 years, for example. Most front-end eurozone govie bonds are offering negative yields. With the ECB about to go shopping, longer-dated paper is going to see yields fall again. The 10-year Bund might not test previous lows, but a 35-40bp yield target over the next few weeks (0.51% now) is a reasonable expectation. So we look for a safe-haven asset class and all roads once again lead to the corporate bond market. The asset class has been sullied by the VW/Glencore event risk, but this type of situation is always going to arise and is difficult to position for. Corporate bonds offer yield and relatively good safety, and getting in early one will also clip some upside.

Don’t swim against the tide, at least drift with the current… Judging by the frustrations of many investors, they’re trying to get involved but finding it difficult to source (enough or any) paper at decent levels. Now that the signs are clear and supportive of a likely sustainable spread-tightening trend, the demand for corporate bonds has intensified. Primary now has a part to play and we think that once we get a few IG prints under our belts, the HY market will also open up. Here the supply has been as low as we can remember since the market became a core one some four years ago. Gazprom’s deal back in August was the last decent print in euros. As long as the eurozone economy doesn’t fall off a cliff, staying wedded to higher-beta portfolio positioning – which requires exposure to the double-B and solid widget-making single-B corporate sector – should pay off in the medium term. We will not ratchet tighter like we did in Q1 because we have a few macro situations to think about and contend with, but Q4 should now be more fruitful than were the soul-destroying second and third quarters.

Everyone’s a winner, it looks good to go… Stocks up close on 2.5% in Europe and 1% in the US as we closed out Friday, government bond prices up/yields down in the week, and the technical dynamic for buying and supporting corporate bonds is back. As we suggested at the end of last week, the corporate bond market ought to curry much favour now into year-end. The iBoxx index closed a couple of basis points tighter at B+157bp and hybrids led the way, even as RWE was downgraded and its hybrid bond rating junked to BB+. There will be few sellers of RWE paper, as sourcing alternative investments offering the same yield will be very difficult. Who cares, they ain’t going bust! CoCos edged only a little better, perhaps as investors are a little reticent about adding because of the impending supply. Cash underperformed iTraxx, but the former can only go better if bonds exchange hands. Poor liquidity means that turnover and volumes are low. The iBoxx HY index was 10bp tighter in the session at B+497bp. Saving the best until last, in the synthetics we had Main lower by 4bp at 70bp and X-Over at 293bp (-20bp), both at current contact lows.

Sometimes it is ok to tread a little less carefully. Have a good week.

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.