18th June 2019

Runaway train

MARKET CLOSE:
iTraxx Main

56.5bp, -4.1bp

iTraxx X-Over

260.8bp, -13.4bp

🇩🇪 10 Yr Bund

-0.323%, -8bp

iBoxx Corp IG

B+134.4bp, -1.4bp

iBoxx Corp HY

B+446bp, -4bp

🇺🇸 10 Yr US T-Bond

2.06%, -3bp

🇬🇧 FTSE 100

7457.02, (-0.58%)
🇩🇪 DAX

13789.00, (+0.79%)
🇺🇸 S&P 500

3386.15, (+0.61%)

It’s all gone Japanese…

The hidden subliminal message is to buy corporate bonds… or anything fixed income, rather. The intraday record low -0.329% yield for the 10-year Bund is clearly milestone territory, but that is not the target level we should be looking at. It’s -0.50% although at this rate, we might be staring at -0.75% soon enough. Long gone is the time when we thought we would never see a negative 10-year Bund yield. In a sense, the Bund has become a commodity and not an interest bearing instrument – driven purely on supply and demand. If traders (the market) think it is going higher, few will care about the ‘arithmetic’ yield.

It’s getting scary but it is also exciting. The 8bp intraday drop in the yield on this benchmark in the session came courtesy of a stampede for fixed income assets as Draghi finally yielded to macro reality – and what the markets were already positioning for. That is, the lack of an improvement in the outlook and the inevitability of more policy action, namely QE and/or a rate cut.

Incredibly, and taking a conservative stance, we might be looking at 7%+ returns for IG credit this year as a possibility which means 12%+ for the AT1 market. After all, we’re where we are without any direct assistance.

The huge rally in government bonds, generating massive total returns of 5.8% year to date in the Eurozone (iBoxx index) has also added much lustre to corporate bonds – which themselves were reeling just a few months back, through Q4 2018. Returns for IG so far in 2019 come in at 5% even as spread markets have been a little shy in resuming much tightening after some considerable weakness in May.

The IG cash index record low yield was 0.83% (Sept 2016) and the record low spread was B+82bp (Feb 2018). Both came courtesy of the ECB’s QE programme. At the moment, these levels reside at 0.91% and B+136bp, respectively. We can probably see a new record low index yield (only 8/9bp to go) without any manipulation of the market by ECB QE activity. Macro is just so bad/worsening that investors expect it though, and Draghi has just suggested it is possible.

For spreads, it has been a little more difficult given that primary is where the action is. But that is going to change. The demand for the current welter of corporate debt being issued is undimmed with deals 3x – 5x oversubscribed almost as a rule, and final pricing 15bp – 25bp tighter versus reoffer (also as a rule). Borrowers are going longer maturity-wise as rates fall, and investors are chasing duration in order to try and get more juice on board.

Next up, we should look for an almighty squeeze in secondary.

There’s plenty of liquidity in the market and one can argue that any additional QE at these market levels would be fruitless. However, whispers or word of another QE programme – which we got in Tuesday’s session – saw market yields drop, precipitously.

The ‘smart’ thinking and trade for a while has been to position for some form of QE – although if it doesn’t come (and we now that Weidmann, for example, if he takes over from Draghi will resist), rates are not backing up. However, in all likelihood it is coming and it has played into the hands of credit investors recently going longer in duration to pick up incremental levels of yield.

Secondary market spreads should show some renewed life now as well. We have been grinding tighter in spreads through June as heavy primary has weighed on secondary. The current run rate of non-financial IG issuance has busted through last year’s reduced volume and is now up at levels seen in the 2014 – 2017 period.

There is likely going to be renewed confidence now from investors to chase the market and the Street will tighten up the offered-side. So the current absolute return levels are at worst sustainable (barring a financial systemic catastrophe) and most likely heading higher. And spreads will be looking at record lows in due course. Race to the bottom? Game on.


Primary markets still churning

The primary market was still throwing up deals, but it took a backseat to the action in the rate markets. Nonetheless, Merck KGaA stole the primary headlines as it reopened the corporate hybrid market with a dual tranche offering, as it financed the $5.8bn Versum Materials deal. They issued €500m in a 60NC5.5 structure to yield 1.75% which was a massive 75bp inside the opening guidance off a book of €5.3bn. This was followed by a €1bn tranche in a 60NC10 structure to yield 2.875% some 62.5bp inside off a €6bn book.

Alfa Laval followed up with €300m of 5-year paper at midswaps+55bp (-20bp inside IPT) with books at just €750m.

In financials, we had Unicredit print €1.25bn in a 6NC5 senior preferred structure at midswaps+155bp (-30bp versus IPT), Bankia took €500m in a senior non-preferred deal at midswaps+125bp (-35bp versus IPT) and Westpac lifted €500m in a 5-year green bond at midswaps+55bp.

Elsewhere, Aroundtown group issued £400m in a perpNC5 hybrid at 5.25% and Sodexo issued £250m in a 9-year at midswaps+100bp (-20bp versus IPT).


Race to the bottom

The big deal in the session was a dovish Draghi. Not that it was needed, but some additional data backing him up came from the Zew German economic sentiment gauge which plummeted in June to -21.1, versus expectations of -5.9.

However, it was the maestro’s comments at the ECB’s conference in Portugal, where he talked of lingering softness in the Eurozone economy amid a difficult inflation outlook, which combined might warrant additional action shook the markets. Adding that the ECB had considerable headroom to launch a fresh QE programme was enough to see record low yields on all longer dated Bunds (5-years+) and we’re now just 8bp away from the 20-year yield going negative as well.

The 10-year Bund yield closed at a record low yield of -0.323% (-8bp), the equivalent maturity benchmark Gilt at 0.80% (-5bp) and the US Treasury was closing in on 2.00%, with the 10-year yielding 2.06% (-3bp) seeing off the 2.01% intraday low, as at the time of writing.

In France, the 10-year OAT yield dropped into negative territory as well intraday, for the first time ever, but came off the lows to close yielding 0.008% (-10bp, the margins matter). Few seem overly concerned about Italy’s budget spat with the EU or its domestic economic malaise, the 10-year BTP 19bp lower in yield at 2.10% representing a drop in well-over 30bp inside a week.

The euro weakened as we might have expected, and Trump was throwing his toys out of the pram as he tweeted about the unfair trade advantages that will come from it. There will be considerable pressure on the FOMC on the follow, and that communique on Wednesday might see us easily well-through 2.00% on the 10-year.

In a clear risk-on day with markets buoyed by hopes of central bank action, equities had a strong session. The Dax put on over 2%, the FTSE 1.2% and US bourses up to 1.5% higher, as at the time of writing.

In credit, protection costs declined leaving iTraxx Main to crunch lower by 4.1bp to 56.5bp and X-Over some 13.4bp down at 260.8bp. The cash market was unsurprisingly tighter, with the iBoxx IG index left at B+134.4bp (-1.4bp) while the high yield market spread tightening left the index at B+446bp (-4bp). HY returns rose to 6.5% year to date. Not bad.

Have a good day.

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.