10th June 2016

Newton’s Third Law

MARKET CLOSE:
FTSE 100
6,232, -70
DAX
10,089, -128
S&P 500
2,115, -4
iTraxx Main
74.5bp, +1.5bp
iTraxx X-Over Index
321bp, +5bp
10 Yr Bund
0.03%, -2bp
iBoxx Corp IG
B+142.8bp, -1bp 
iBoxx Corp HY Index
B+472.5bp, -2.5bp
10 Yr US T-Bond
1.67%, -3bp

A reminder, it’s not all THAT rosy…

The ECB is buying and spreads are (or will be) going tighter – everywhere. The world is all agog as to how much it might buy or can buy, and whether it is almost completely price-insensitive. We’re all wondering how this might impact corporate treasury desks’ funding plans, how much they might decide to print as costs drop and who the issuers might be. Slicing it and dicing it will be an interesting exercise and may make for a good pie-chart in a presentation. But cutting through the wheres, wherefores and whats, we all know that every issuer and bond will benefit (maybe eventually by the same amount, or by more for the non-fancied ones as they will be cheaper).

We will be happy right now as spreads tighten, yields drop and borrowing costs fall, while performance versus benchmark and total returns rise. But we will be frustrated eventually as secondary market liquidity worsens (it is already poor) as Street inventory drops precipitously. Thus the ECB starts to become a nuisance, fixing a market which isn’t broken while forcing investors to bail out the very “system” it has failed to directly rescue itself. That is, investors take on ever more increasing risk. The pain always comes. We won’t see it. We will just feel it when it does.

Record low yields spur returns

Brexit fears, record low Bund yields and weaker equities saw 10-year Gilt yields touch 1.224% and a new intraday record low. brexitThe move makes sense however one looks at it: fear of the Brexit Leave camp being successful, the relative value aspect versus Bunds and other Eurozone debt yield, and the flight to safety/quality trade. Sterling credit spreads might not be tightening (they have remained unchanged over the past four weeks) like their dollar or euro-denominated corporate peer groups, but the rally in Gilts is resulting in sterling corporate credit outperforming on a total return basis, where returns YTD sit at a stunning 5.8% (Markit iBoxx £ corporate index; € returns at 3.5% in the same period).

That will go materially higher if Vote Leave wins, as the ensuing mayhem might see the 10-year Gilt yield drop to below 1% – for however brief a period that might be. Should Vote Remain succeed, then we can expect a rise in Gilt yields, but it ought to be modest as it will be capped by the relative difference with German government debt. There’s a trade in the volatility somewhere.

The 10-year Bund yield reached a record intraday low of 0.023% yesterday, 3bp lower in the session. Adding to the grind could be that traders have sold Bunds (futures) against their corporate positions. As they now sell corporate inventory into the ECB, they need to lift their hedges – and no one wants to be short. Anyway, we wrote previously – when the yield was in in the teens – that it wanted to go to zero/negative, and questioned whether it was such a brave trade to put on. There have been big pullbacks before all the way to 1% after seeing a low of 0.24% last year. Not this time – not for the moment anyway. The Eurozone economic crisis has reached a new low (no pun intended), as judged by the markets and central bank interference in them. The exit – any exit – is going to hurt. In a way, it’s better they keep pushing on that string so as to put off the inevitable.

Purchase programme start a damp squib

bunge-finance

The sole new deal was f0r Bunge Finance

So far, the ECB’s corporate bond purchase programme has failed to excite. It’s lifted what it could in secondary and just small clips at that, because that’s all there is available. But more interestingly, primary has failed to feed the beast. The only new (and eligible) deal since the bank started purchases has been yesterday’s €600m Bunge Finance transaction. The ECB aside, issuance this week hasn’t been overly fantastic, with just the aforementioned IG offering (and a €300m deal from Ipsen – unrated, likely low triple-B) since Wednesday. Still, the monthly level has reached €6.7bn for IG and we’re barely a week into June. HY continues to flourish – kind of. We managed another €650m there, with issues from Outokumpu and Tereos, leaving almost €2.5bn issued this week. There were also a couple of uninspiring senior deals from ASB and DVB Bank.

We closed out with equities suffering again, and European bourses off by 1% or more. The DAX was in the bottom grouping, off by 1.3% and the FTSE by 1.1%. Oil was lower but Brent was still holding around the $52 per barrel level. The 10-year Bund closed yielding 0.03% (-1bp) and the equivalent Gilt 1.24% (-1bp). Not wanting to be left out, 10-year Treasury yields fell through 1.70% to 1.67%. A rate hike in the US next week would be a shock.

And finally, the credit markets continued to do their own thing. Stocks might have been lower and the iTraxx indices higher as the cost of protection rose in a risk-off like day, but the cash market was only going one way. Tighter. The Markit iBoxx index yield dropped to 1.21% and spreads to B+142.8bp (-1bp). It is the lowest index yield since April 2015 (record low is 1.02%). In HY, we had spreads also tighten in a very limited session flow wise, by 3bp to B+472.5bp and the index yield was down at 4.40%. So far, it’s going to plan for the ECB.

Have a good weekend.

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.