6th June 2016

Living on borrowed money

MARKET CLOSE:
FTSE 100
6,210, +24
DAX
10,103, -105
S&P 500
2,099, -6
iTraxx Main
76bp, +1bp
iTraxx X-Over Index
328bp, +3bp
10 Yr Bund
0.07%, -5bp
iBoxx Corp IG
B+146bp, -0.5bp 
iBoxx Corp HY Index
B+486bp, -0.5bp
10 Yr US T-Bond
1.70%, -10bp

You don’t issue UNDER the CSPP…

The ECB’s corporate bond purchase programme is not a “cheap funding vehicle” for issuers to print debt and to dump their wares. We should not be viewing it as some kind of SPV (Special Purpose Vehicle). There are no guarantees and no formal documentation that suggests it is a sort of “structured vehicle”. It might look like one, feel like one, suck up assets like one too – and it can never go bust. But it isn’t one of the kind we market participants once knew and loved way back before the crisis! It’s a third-party investment manager that the ECB has designed to manipulate corporate bond prices (higher) such that yields fall and corporates can raise debt at ever lower cost.

The idea is that it might eventually create an additional transmission mechanism such that this cheap funding flows into the wider economy – be that through higher capex, investment or even M&A at the corporate level. By essentially subjecting IG corporate bond investors to a lower return regime, the central bank is forcing them to fund higher-yielding entities (and take on more risk), pushing funding costs lower there too. When the cycle eventually turns, someone is going out in a blaze of glory – and the ECB then risks becoming the corporate bond market’s “bad bank”.

This extended low(er) rate environment should not be lost on Joe Public, as the unedifying prospect of even lower deposit rates results in a likely preference to hold hard cash – and then the temptation to spend it. Or put it into other fixed income-generating assets (like property – and create a bubble there, like in the UK). The risks are certainly escalating. And as for the “oldies” of tomorrow and pension investing, that’s someone else problem.

Crash, bang, wallop… US rate hike off the agenda

It’s not so much a lift-off as a crash landing around the likelihood of that June rate hike! The Treasury market’s reaction tells us that. While the non-farms report might have served up a curveball for the Fed, the ECB won’t be happy either. We just seem to be sinking and the pace is accelerating. If – as the recent data suggests – the US is going to struggle to grow in any meaningful way, then the eurozone isn’t going anywhere either. There will be euro strength versus the dollar – and with China also facing its own troubles, that must mean further easing in the eurozone. We think it could come in the fourth quarter of this year. That gives the ECB 6 months to see how the additional €20bn a month and TLTRO play out.

A measly 38,000 jobs added and revisions lower in previous months point to slower and lower for longer. It left the markets and policymakers flummoxed. Yields plummeted, stocks dropped, oil fell and credit did very little (as we have now come to expect). Returns for corporate bonds look better though – much better – as the underlying rally boosted bond prices.

Record lows are on the way. The 10-year Bund is back to yielding single figures at just 0.07bp (-5bp on Friday) and is on the way to dropping below the previous record intraday low of 0.047% – and we believe it will join the negative territory-yielding bandwagon. Brexit may or may not happen, but either way, Gilts are closing in on their lows of 1.23%, now residing at 1.27% (down 7bp on Friday alone). Corporate bond yields are also going to fall, and once spreads start crunching tighter as the ECB goes shopping come Wednesday, we could be looking at record low index yields (iBoxx, IG of 1.02%) before this year is out (25bp to go).

For stocks, weaker macro means weakness in earnings. There has been so much cost-cutting over the last few years that the contribution to future earnings from it will wane hard. Any further cheaper borrowing costs will also have a more limited impact on earnings. Lower capex and investment will just decline some more. The low-hanging fruit, so to say, has been well and truly picked. The DAX closed out last week at 10,103 (-100 in Friday’s session and 200 points lower on the week), but the US managed to close off its lows with the S&P at 2,099. Treasuries rallied hard, with yields 10bp lower or more across the curve (front end outperforming). There’s a clear message in there.

Austerity and recovery a marathon, not a sprint

The not too cold, not too hot dynamic on macro has been a boon for corporate bond market investors. We’re still in the slipstream of a fragile macro technical dynamic and so continue to think that corporate bond returns will hold up. However, and without getting too carried away with it all, the latest data points would seem to suggest we’re struggling to find a way out of the low-growth malaise and the US is succumbing again. There’s method in the madness of the ECB’s policy (lowering even more borrowing costs for everybody), but they’re sowing the wrong type of seed. While they figure out how wrong and look for the right formula, we find it necessary to buy into the corporate bond market, one of the few fixed income asset classes left producing (usually) some income while (usually) also preserving capital. Fingers crossed we’re not soon writing “used to” instead of “usually”!

In credit, cash was fairly quiet, though we did get a hybrid deal from SES for €750m, rated Ba1/BB+ but it will appeal to IG investors as much as – if not more than – HY market funds. The secondary market closed unchanged, but the index yield fell to 1.27% (Markit iBoxx IG) and that’s now the lowest since the end of April 2015. The 4.55% index yield in HY was last seen in August of last year. For the shorter duration HY to go lower, we now need credit spreads to start rallying, given that we’re negative in Bunds all the way to 9 years and the 2-year is at -0.53%. That performance will come, we believe, as a consequence of the ECB’s bond-buying programme crowding out investors in IG and subsequently expanding the universe of players interested in HY markets.

That’s it for today. Back in the morning.

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.