20th June 2016

“The price of greatness is responsibility”… Churchill

MARKET CLOSE:
FTSE 100
6,021, +71
DAX
9,631, +81
S&P 500
2,071, -7
iTraxx Main
85bp, -2bp
iTraxx X-Over Index
369bp, -12bp
10 Yr Bund
0.02%, +4bp
iBoxx Corp IG
B+149bp, -1bp 
iBoxx Corp HY Index
B+513bp, -1.5bp
10 Yr US T-Bond
1.61%, +3bp

Brexit: Bring it on…

Little else will matter this week but the UK referendum as the country goes to the polls to vote whether to stay in or leave the EU. Be sure to expect a tetchy week, with markets up or down by small or large amounts depending on the prevailing newsflow around the opinion polls. We think most will look to stay sidelined into any of the potential volatility, with some severe moves after – whatever happens. A “Remain” win and we can expect Gilt yields to go higher, sterling to recover, equities everywhere to bounce and risk assets generally to rally. That is, the relief trade – better the devil you know and all that. A “Leave” success and we can expect sterling to drop sharply (not for long), Gilt yields to decline (flight to safety), equities to fall hard in the UK and likely elsewhere too, while credit will weaken but more on trader caution than on any meaningful selling into it. The iTraxx indices will rise sharply, though, as hedging trades and the like see investors seeking to buy protection.

A “Remain” victory and we move on to the Spanish elections with the markets in upbeat mood. However, we happen to think that a Leave win will offer much opportunity in any immediate aftermath of market weakness. Several years of negotiations are to follow in this case, and that initial market reaction will, as always, be an overreaction to the actual event – and an opportunity. Taking no chances, we closed last week in subdued form and could have expected a better end to it,  as investors might have closed short positions or taken the moment to pick off cheaper assets. That didn’t materialise, and the recovery was extremely measured and felt nervous if anything. There wasn’t a single new issue priced anywhere in euros, capping off a very poor week for the primary markets.

Volatility and panic towards negative yields

We closed last week with some positive data from the eurozone as seen in the pace of wage growth across the region of 1.7% in Q1 2016. The region’s record current account surplus also rose to a record €36bn, capping off a 5-year run of surpluses with the rest of the world. The key story though will be the incredible shift towards negative government bond yields. The 10-year Bund saw -0.038% (now 0.02%), the equivalent Gilt a low of 1.07% (now 1.14%) and the 10-year Treasury a 4-year low of 1.52% (1.61%), while the whole of the Swiss government benchmark curve went negative at one stage (the 30-year currently yields just 3bp). For stocks, the late May/early June recovery and positive tone were completely reversed as markets took some major hits. The DAX is now down 11% YTD, the FTSE is faring better down just 3.5% while the S&P is up 1.4%. That will all look materially different at Friday’s close of business! Oil prices saw good recovery into the end of the week, with Brent up 4% in Friday’s session to $49.2 per barrel and while prices have been anchored around this level for a few weeks, it’s not gone unnoticed that the US rig count has perked up a little.

Primary markets slump to continue

There has been confusion in some quarters as to why supply this month has been so light. That’s because many had expected a swathe of prints into the ECB’s lift-fest, but that has not materialised. We have long argued that the ECB’s participation in the corporate bond market would not necessarily herald a massive pick-up in supply, even though it is – or will eventually become – a boon for the market, in terms of lowering yields and tightening spreads and therefore lower funding costs. Corporates can afford to wait. Admittedly, the recent volatility might have had something to do with borrowers preferring (or being advised) to stay sidelined, but we think deals would have got away despite it. Generally though, the corporate sector can wait, because it knows the ECB’s backstop bid for corporate bonds will ensure that funding costs stay low for longer and there is no need to rush pre-Brexit or after, because once the markets calm they can pick and choose their timing.

As a result, the month so far – with just a week or so of business to go – has been quite poor for IG non-financials and just €9.9bn has been issued. That said, June last year only saw €9.7bn of issuance versus €16bn in June 2014. But given the blockbuster issuance in May (over €45bn), we would have anticipated a heavier level of supply this month. Senior financials haven’t fared any better, with just €9bn issued. However, we have been pleasantly surprised at the near €5bn of HY corporate issuance, with this market just a couple of deals away from June becoming its best month so far this year. And the HY issuance has come into much volatility that has seen HY spreads widen by a considerable amount over the past week in particular. For this week, and with the referendum in the UK looming, we can expect less supply from all market sectors as the corporate bond market moves into wait-and-see mode.

Corporate spreads holding up well

Primary offered very little, we will see how much the ECB has lifted later today, and news flow around the corporate sector has been very light. But at B+149bp (+6bp in the week), the Markit iBoxx IG index is now back to mid-April levels. This index is still 5bp tighter this year, while the index yield at 1.23% is some 53bp lower – highlighting the huge contribution to total returns the rally in the underlying is having. In HY, spreads closed unchanged but were still 37bp wider in the week, and at B+513bp the index level is also back at those mid-April levels. Sterling cash was also wider, the index left at G+187bp and yields a little higher in the week. The better close in European stocks on Friday helped the indices counter some of the previous weakness, with iTraxx Main and Crossover closing at 85bp and 369bp respectively. Activity is going to be heavy this week as the market positions into each referendum poll that is released and then the eventual result.

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.