29th Feb 2016

A leap into the unknown

MARKET CLOSE:
FTSE 100
6,096, +83
DAX
9,513, +182
S&P 500
1,948, -4
iTraxx Main
103bp, -6bp
iTraxx X-Over Index
421bp, -18bp
10 Yr Bund
0.15%, +1bp
iBoxx Corp IG
B+185bp, -1.5bp 
iBoxx Corp HY Index
B+638bp, -6bp
10 Yr US T-Bond
1.76%, +5bp

An extra day – like we need one!… 29th of February it might be, but we will need more than a leap of faith to think that the eurozone’s troubles are over. Last Friday was yet another day (we’ve had many of them) where the newsflow was just dire. So dire that we need no convincing the ECB will throw a little more at the eurozone’s problems. The prospect of even more cheaper money ensured equities managed to close out the week (and the month) on the front foot, dragging all risk asset pricings with them. Credit spreads went tighter, oil was up and beaten-up currencies saw some reversals, while eurozone government bonds held firm. Because, rest assured, stimulus will prop up the asset bubbles – so we may as well buy into it. The eurozone is in a deflationary vortex, YoY Italian wage growth for January was at multi-decade lows and the latest economic confidence survey showed another drop in February. Areva and Telefonica reported huge losses as restructuring costs (a theme for Q4 earnings) took their toll. That adds to a gamut of already weak data across the board for the eurozone. There’s no hint of a recovery, nor even a sign that the downward spiral is coming to a end. It was quite different in the US, where Q4 GDP was revised higher and inflation (through the Fed’s preferred PCE measure) was very strong in January. Recovery and a rate rise in the US? Well, while we enjoyed a very strong session on Friday in Europe, the US was dithering on the prospect of higher rates and Treasuries backed up significantly. Generally though, we close out February with returns on the up for all asset classes and out of the big three euro government bonds come top, with corporate bonds in second place and equities still languishing (see chart below).

2016 returns comparison: Jan-Feb

Sterling corporate bonds under pressure… While we see recovery in terms of returns off some quite significant lows at the end of January, sterling corporate bonds are feeling the heat. Returns here have fallen to -0.7% for the two months of 2016, from a small positive at the end of January (Gilt rally). It has been a poor month, and the weakness was not all necessarily a result of the Brexit debate. For instance, sterling corporate spreads are 60bp wider YTD, with the widening split evenly between January and February. It is unlikely that we are going to see any recovery any time soon as the debate rages on, and we would think that any ECB action in a couple of weeks’ time which might help euro corporate valuations will be lost on valuations in the sterling corporate bond market. That aside, euro-denominated IG corporate bond markets have had a decent run, with returns up at 0.8% YTD but all the upside coming because of the strong government bond market. Spreads as shown in the Markit iBoxx IG corporate index were 11bp wider in February and 30bp for 2016 so far. Financials are showing a very small negative return year-to-date. In HY, the picture is less upbeat. HY total returns have worsened to -2.4% and spreads in February gapped 50bp (+110bp YTD). This was to be expected given the ongoing (energy related) troubles in the US HY market and weaker equities, and the correlation they have with European HY markets. Equities have been volatile and ended the month mixed. The DAX is off a little more and is now showing a decline of 9.3% in 2016, the S&P 500 recovered a touch to -4.5% and the euro Stoxx 50 is some 10.3% in the red. IG credit loses out only to eurozone government bonds, which are up a stellar 2.5%.

But improvement elsewhere… We closed out strongly last week. The iTraxx indices crunched lower, with Main left at 103bp (-6bp) and X-Over at 421bp (-18bp) – the latter staring at 500bp about two weeks ago! Cash credit was similarly better, but given the tone in stocks we could have expected it to be more upbeat. CoCo prices were only marginally better, for example. Few are chasing anything. Still, we saw a broad recovery such that the Markit iBoxx IG corporate bond index moved lower to B+185bp and the HY index to B+638bp (-6bp). In government bonds, the 2-year Bund yield was at -0.55% (record low) while the 10-year closed the final session unmoved at 0.15%. The 10-year BTP yield fell to 1.47% (-4bp) and the equivalent Bono to 1.57% (-3bp), while a well-received Portuguese budget helped push yields there some 25bp lower to 3.05% (10-year). We’re not betting against there being more to go.

No more earnings-related blackout excuses… Primary corporate bond market supply so far this year has been extremely poor. Multi-billion, multi-tranche deals of a combined €10bn from Vodafone and Honeywell have made the total IG supply look a little respectable at around €27bn YTD. Gone are the days when we might have seen that much printed in each of January, February and March. Clearly, the turmoil we have seen in the global markets – or rather the extreme volatility – has had an impact, and borrowers have shied away from accessing the markets for funding. We could probably think that borrowers are not desperate as they have plenty of cash board and those that might need funding for general corporate purposes can afford to wait. After all, they have managed to build cash balances at all-in record low funding levels over the past few years. And judging by the way markets are going, they will have plenty of opportunity through 2016 to continue with their advantageous funding levels. Senior bank issuance is up at €32bn YTD and the now-closed HY market languishes at just €1.7bn YTD with only €400m printed in February.

A new month could bring some joy… We kick off with the Super Tuesday votes being cast in 11 states as the Democrat and Republican candidates battle it out: Clinton vs Trump in the final presidential fight? We close out the week with the non-farm payrolls report (190k consensus), and we have US manufacturing and construction surveys in between. Elsewhere, Chinese, UK and eurozone manufacturing PMIs are due. Then we look forward to the ECB gathering in the second week of March, and there will be much anticipation and apprehension into this. We think that the data this week will only serve to underpin the need for further action. If they deliver – and it is by no means certain they will give the market all it wants (they haven’t before) – then we are set up for a quarter performance-saving March rally. There will be a ratchet higher in stocks and the improved tone from it will boost corporate bond spreads, which will provide a boost to the primary markets.

Have a good day, back in March.

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.