- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
Until it isn’t…
Waiting for the Fed’s communique curtailed activity in the session, but that isn’t stopping most of the market from anticipating a major pull back in asset prices. That fall from grace is bound to come & is not necessarily imminent, nor is the event which provokes it easily identifiable. After all, we’ve had decade worth of event-risk crammed into the last 15 months, and the markets have taken it all in their stride.
Taking a clichéd approach to it all, we would think that ‘everybody’ needs to go ‘all-in’ before the big sell-off comes. In that sense, there is a lot of slack (read liquidity) in the system to keep us propped up and so the race to the bottom continues. So, expect more of the same.
That means equities in the US will likely continue to push at those record closes (This will not always be one way, though), and we think European equities will gather some momentum in due course. We might need to get used to the stronger currency, though, while some transparency around the timing of the ECB’s QE taper would also be welcomed. We are not looking for rate markets to sell-off much such that yields on, say, 10-year Bunds shoot past 0.70% by year-end, while we might be an event or two away from seeing 0.20% level. That type of uncertainty might be enough to see the 10-year play out in a 0.30 – 0.60% like range over the final quarter.
For credit, nothing changes. We stay risk-on. Higher beta corporate risk remains the place to be. There will be no traditional sell-off in this asset class. It has tripled in size to become a market of over €2trn for IG and HY corporate bonds combined in the last 10 years (Markit iBoxx) and there is a level of permanence to the cash invested in the market. And money still continues to flow into (predominantly IG) funds, even as spreads there edge closer to record lows. We are looking to get those record tight spreads again for the high yield market over the next few sessions, perhaps.
We’re even differentiating the level of risk between different AT1 issuers, such that a credit event doesn’t necessarily have a contagion impact on the rest of the sector. It has returned a remarkable 12% YTD and promises more as spreads resume their tightening trend having widened with the market through August. A sign of maturity? Or are we just kidding ourselves that this ‘designed to fail’ product won’t fail for Sifis because the banking sector is rock solid resolute and has greater levels of strength now, after the politicians and regulators scurried to secure the financial system’s integrity and robustness, post crisis?
FOMC loomed, market almost stops
Few were willing to take a serious position in the session, it seemed. Time and again, FOMC-day has the knack of bringing the markets to a standstill of sorts. Equities did very little in the session and were up or down by the smallest amount, barely threatening to pop out of a narrow range throughout the session.
News flow-wise we had UK retail sales for August rising by much higher than expected at 2.4% versus expectations of 1.4%. Sterling shot higher and rate markets were looking at the November MPC meeting for a hike in the UK base rate. We don’t think they ought to raise rates, but we suspect that the MPC might think that it will be ‘safe’ to do so, especially if the market is not going to be surprised by it. There’s still a lot wrong with the UK economy.
Gilt yields edged lower for most of the session, but closed unchanged in the 10-year, left at 1.33% and we saw a similar picture replicated in other markets. Bunds were yielding 0.44bp (-1bp) and US Treasuries unchanged at 2.24% -1bp – all before the Fed communique was released, and at the European close.
The corporate primary markets were alone in offering up some deals to keep credit investors occupied. For the non-financial sector, we had unrated Voestelpine for an increased €500m in a 7-year deal priced at 20bp inside the initial guidance at midswaps+95bp. The borrower’s debt trades well, and we think is probably a X-Over name. They were joined by Brenntag AG which came in for €600m in an 8-year deal, also priced 20bp tighter versus the initial mumble at midswaps+60bp.
In financials, we had Santander Consumer Finance print a 4-year deal for €500m and Mediobanca take €750m in 5-year funding. Aussie based REIT Goodman Australia funded €500m in an 8-year transaction to wrap us up for the session.
For the iTraxx index players, the FOMC probably fell on a convenient day as it left them to focus on the new Series 28 contract roll. As it happened, Series 28 Main and X-Over rolled about 7bp and 35bp wider versus the Series 27 closing levels once the new constituents were added and old ones removed. At the close, we had Main at 57.3bp and X-Over at 256.6bp.
The cash market in IG closed unchanged with the Market iBoxx cash index at B+107.2bp with very little activity in secondary. In high yield, it was pretty much the same, the index left at B+283.7bp (-0.5bp) – so effectively unchanged. That’s the Fed for you.
Anyway, the FOMC left rates unchanged as was largely expected, but importantly, will start to reduce the size of its $4trn+ balance sheet from October – while any rate hikes will be limited in their frequency (December?). After all, the Fed saw fit to raise its 2017 growth forecasts (to 2.4% from 2.2%) but lower inflation ones (to 1.5% from 1.7% for 2017). Now we can just get on with it.
Treasuries initially sold off a little, as the 10-year yield rose to 2.28bp (+4bp) along with a very slight flattening of the 2s/10s curve but then recovered to pre-announcement levels, which was a muted reaction all being told! Equities didn’t really move much on the news, registering a small decline only – before they ended the session in the black, just!
Have a good day.
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