2nd September 2016

Dare more give it a go!

MARKET CLOSE:
FTSE 100
6,746, -36
DAX
10,534, -58
S&P 500
2,170, unchanged
iTraxx Main
69bp, +1bp
iTraxx X-Over Index
314bp, +5bp
10 Yr Bund
-0.07%, unchanged
iBoxx Corp IG
B+119bp, -0.75bp 
iBoxx Corp HY Index
B+416bp, +1.5bp
10 Yr US T-Bond
1.56%, -2.5bp

There’s life after an EU exit…

who-dares-winsWell, that was a poke in the eye, if ever we had one. UK manufacturing activity – having fallen sharply into the referendum vote, recorded one of the sharpest monthly comebacks ever. Up at 53.3 versus 48.8 previously, the manufacturing sector is on a roll – backed by a weaker currency with both domestic and overseas orders flooding in. Recession and even another rate cut might now be avoided (an emergency budget already has) as the UK embraces that weaker currency, making hay while it lasts no doubt.

The equivalent PMIs showed that Germany remains perky, France is in the doldrums (recording another contraction in activity) with Italy not far behind with the Eurozone overall barely expanding. It might not last though, as the pound surged. Gilt prices fell too with the 10-year yield rising to 0.70% (+5bp), the downside being that this will ultimately eat into those super returns sterling corporate bond investors were hitherto sitting on. They’re still fantastic.

Otherwise, we anticipated (and endured) a very limited session. Chinese PMIs surprised to the upside and with non-farms out on Friday, Thursday’s session was fairly limp from an activity perspective. The only deal of note was a Holdco senior offering from Santander in a 7-year maturity. There ought to be nothing in today’s session and the focus will on be next week’s possible supply.

We highlighted the excellent monthly performance in yesterday’s comment, but the entire year to the end of August has also been fantastic for just about all. After the dark period in Jan-Feb, most asset classes have recovered well, albeit following a dose of QE to keep the patient ticking over. The DAX had recovered some serious losses to be just 1.4% lower at the end of the opening 8 months, while the FTSE was up 8.5%. IG credit total returns were up at a superlative 6.2% while HY returned 7.1% in the year to the end of August.

Euro-denominated non-financials were up 7.1%, but if recovery looks likely then financials will perk up and improve markedly from the 4.5% returns so far this year. The winners, though, have been investors in the sterling corporate bond markets, where the Markit iBoxx sterling index was returned 16.7%.

Selected sector returns to end August

 

uncharted

Unfamiliar: The current economic climate

Under normal circumstances, IG and HY returns pitched at around 3-4% and 6-7%, respectively, in any given year would be taken as being a very satisfactory performance. That would be enough to keep cash invested in the market, redemption proceeds rotated back in and pitching for new business made simple helping additional cash enter the market to keep it supported. We’re in uncharted territory with macro severely disjointed in a world riddled with over-indebtedness.  We have an unprecedented QE experiment and a sustained low/negative rate environment again never seen before.

Policy actions may or may not control the eventual outcome – where hoping for growth, inflation, jobs, consumption is no longer a “gimme” by tweaking rates of fiscal policy.

With all that to contend with, the best we will get is more of the same. For us, that means the corporate bond market will continue to grind tighter (in spreads), lower (in yield), the default rate will stay low, the bubble will expand some more but returns when we reset the counter for 2017 will not come in at anywhere near these levels as the juice runs dry.

On the default front, overnight S&P published their latest default report and is showed that the speculative grade default rate in Europe rose to 1.9% on a 12-month trailing basis. That is super low! What does that all tell us? One has to be very unlucky to hold debt of a company which might eventually default. In the US, the equivalent number was 4.8% for the default rate in the same period.

US manufacturing data and car sales disappoint

It all started so well for the first day of the month, but the more upbeat opening lines to the new chapter faded. Ford and GM announced a larger than expected fall in auto sales for August, while the US factory sector contracted in August as reported by the 49.8 print in the ISM. It seems that dollar strength and a weaker global economy have weighed on the US manufacturing sector and this will have given the Fed some food for thought as they reflect on whatever the payrolls will be telling them later today. We’re still thinking no rate hike come the next FOMC.

Anyway, the immediate response of the market was for equities to go lower, government bonds managed a tentative recovery bid after some early weakness – but that will strengthen more, especially if any subsequent data suggests easy policy (or no reversal in the US) for longer.

We dare think that equities will stabilise and once analysts have figured out what the medium growth outlook might look like, equities will be re-rated (especially if those rates don’t move in the US). Credit stays solid, unmoved by it all, supported by central bank buying programmes and economies plodding along at low growth levels.

So we closed out with Bunds unchanged while Gilts managed some recovery from earlier weakness, the 10-year eventually closing to yield 0.67% (+2.5bp). Equities were lower, as stated above. In the corporate bond market, we stayed firm as expected. Spreads edged lower in IG to B+119bp (some month-end index effects in there too) as measured by the Markit iBoxx index in a light session, with nothing in primary apart from that Santander deal. In HY, a very quiet market saw spreads effectively unchanged although the index moved up a little but largely due to month-end effects.

That’s all for this week. Have a good weekend, back on Monday.

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.