25th January 2016

The Emperor’s New Clothes

FTSE 100
5,900, +126
9,764, +190
S&P 500
1,907, +38
iTraxx Main
iTraxx X-Over Index
10 Yr Bund
iBoxx Corp IG
B+178bp, -3bp 
iBoxx Corp HY Index
B+609bp, -20bp
10 Yr US T-Bond

Meowww!… That was a dead cat bounce if ever we saw one. The Nikkei up 5.9%, for example! No news, just hope that more ECB largesse and oil zooming through $30 per barrel will do the trick and turn sentiment round. It’s nothing to do with expectations of a shift in fundamentals – like a change in political will and thinking requiring the need for some hard-hitting reform, instead of relying on a non-relevant, yet classic standard response to an economic crisis. Nope. It’s all about avoiding going cold turkey. Still, that helped boost all assets at the back end of last week as the drugged-up marketplace was placated by Draghi’s words. It might last too, as any weaker data will have the markets clamouring for, and putting intense pressure on the ECB to make a move in that March meeting. That is, we know stimulus is coming and the markets could well trade into it in a sustainable fashion. We would tread with extreme caution, because at some stage we’re going to realise that more easing is not what is going to save us from crashing asset bubbles. Only reform will do it – but unfortunately, that will also mean much pain. It will mean an extended period of low growth, higher unemployment, likely significant belt-tightening and new governments. Given that that is unpalatable right now (as it generally is), we continue as is and retain the status quo policy mix. We start by forcing the ECB into a corner – where it usually disappoints – then we push it some more until it relents and delivers the dose of medicine the market is crying out for. And we rally. We should be used to this; we have had several years of this kind of cycle of events already. Quite obviously, most want this to be the turnaround (we do), after what seems to have been an unjustifiably large sell-off given there has been nothing systemic yet. But who is really going to believe in it and add any significant risk (assets have cheapened a lot after all)? We think few will, because any bad news will see a resumption of the down-leg in markets – and that could come from the oil sector, China or a misplaced word from the Fed next week, for example. We think that the broad sense of panic could well be over, but that any recovery in asset prices will be slow. If we can end this week stable to better, then January’s performance in credit will look the best of a bad bunch and may dampen fears that we will see material outflows from funds.

Topsy turvy week ends with a big bounce… Asia kicked us off into the close and although Chinese stocks closed 3% lower, the Nikkei’s recovery really set the ball rolling. Oil closed up a whopping 10%, with Brent and WTI at $32 per barrel. Even the rouble recovered! US stocks held firm through the session, up 1.5-2.5%, and the 2-3% rise in European equities completed an excellent recovery session for equities. Govies only gave a little back, with the 10-year Bund yield rising to 0.47% (+3bp) while the 2-year remained anchored at its closing record low of -0.45%. The 5-year is at -0.23%. Peripheral yields gave nothing back, with Spain and Italy holding firm and closing at 1.72% and 1.57% respectively. All these will be beneficiaries if the ECB expands/extends QE. The 10-year Treasury gave up a couple of basis points to yield 2.05% at the close.

Credit rides the waves too… Into the euphoria, the synthetic credit indices pulled back from potential double whammy 100bp Main/400bp X-Over levels to a more respectable 92.5bp for Main and 368bp for X-Over. Returning confidence and sentiment from higher equities saw to that, and equities will continue to dictate where the indices ultimately go. In cash, the market moved in more circumspect fashion in investment grade, but we saw somewhat a bigger recovery in high yield. Positions, if taken in haste, are going to be difficult – rather expensive, to unwind. So, the Markit iBoxx IG corporate index closed at B+178bp (-3bp in the session, but one basis wider on the week). Returns in IG are now at -0.25% for all three weeks of the current year. In high yield, we had a 20bp recovery in index spreads on Friday alone, leaving us just 8bp wider in the week at B+609bp. Total returns, in this short year-to-date are at -2.8%. These are good recoveries but the spread moves are indicative of an highly illiquid corporate bond market Spreads are marked significantly tighter or wider with little flow or volume to justify it. For the first time outside a holiday period (summer/Christmas), there was no primary last week at all in the corporate bond sector, understandable given the huge volatility we experienced. We would think that this week ought to bring us a few deals, especially if we get a day or so of further calm. The blackout period associated with the earnings season will curtail anything major though which will leave January as being one of the poorest such months for the primary markets ever seen.

Have a good week, back Tuesday.

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.