8th December 2015

Cycles not in sync

MARKET CLOSE:
FTSE 100
6,224, -15
DAX
10,886, +134
S&P 500
2,077, -15
iTraxx Main
71bp, -2.5bp
iTraxx X-Over Index
292bp, -11bp
10 Yr Bund
0.58%, -10bp
iBoxx Corp IG
B+147.5bp, +0.5bp 
iBoxx Corp HY Index
B+473.5bp, +7bp
10 Yr US T-Bond
2.22%, -5bp

No longer riding in tandem… It’s always about the cycle. That cycle might be heading upwards in the US in sustainable fashion. The means economic recovery: growth, inflation, supposedly improving corporate profits (eventually) and perhaps higher but manageable debt levels. That ought to mean tighter spread levels as corporate bond spreads feed off improving debt metrics (ability to service obligations improves). After 7 years we have some lift-off in the US with the Fed looking odds-on to raise rates next week. In Europe, it is a different story and following the US’ cyclical recovery with the customary rule-of-thumb delay of 6-9 months isn’t going to happen this time. Zero, negative, low global interest rates are here for a reason and those issues have not been addressed. We have no such cycle or chance of a classic cyclical recovery that the US might be witnessing in Europe. Everything we have seen thus far from both sides of the Atlantic has been unprecedented – rates, yields, QE, level of spreads, the stunningly low default rates amid low or no growth and the longevity of this crisis.

So, we think dollar spreads in IG might outperform those in euros, but returns will not in 2016. We think HY spreads in the US will underperform those in Europe as the shale boom turns to bust and the contagion impact overwhelms any upside other HY sectors might get from improving economics. In Europe, there might be a small contagion impact, but spreads will outperform here versus the US and returns will too. Rates going up in the US and with them yields on Treasuries may once have pulled Europe yields higher in their slipstream. But we think the nature, response and impact on the different regions of the financial crisis will no longer see them as closely correlated as they once were. Euro-denominated credit therefore should be the winner versus dollar debt, but with spread outperformance versus the benchmark likely to be small, and returns very low, it’s nothing to be overjoyed about. Using the Markit iBoxx eurodollar index as an example, US dollar spreads were 17bp wider YTD and returns at zero – and that is after a big back-up in yields especially at the front end, as at the close of business last week. The maths for euro-denominated credit shows spreads were 36bp wider and returns at -0.75% for the same period.

Little sign of a flurry of activity… We’ve been saying for a while that we anticipated a flurry of activity this week, and quite possibly in the very early part of next week, but it was not to be. The IG non-financial corporate market saw nothing, with senior financials serving up Svenska Handelsbanken with a 7-year benchmark at midswaps+70bp on books over Eur2bn. We had Commerzbank in a shortish dated Eur500m at midswaps+60bp while Honda, Total and Westpac all kept the sterling community busy and happy with taps and other deals in that currency.

Action everywhere except corporate bonds… It felt like a December Monday ought to in the secondary corporate bond market. Quiet. That’s not saying it was the same elsewhere! The story away from interest rate speculation is oil.Oil Speculation And oil came under some big pressure after the effective lifting of that Opec production cap at the end of last week. Add to that higher output with a weaker dollar and the decline in (Chinese) demand, and we have an unholy concoction that will keep oil prices depressed for a while yet. WTI fell 5% to the $37.80 area and Brent to below $41 (-$2.2) – both being multi-year lows (2009). The oil glut, and the sluice gates fully open will lead to sustained low (or lower) prices which means the disinflationary forces in the broader economy will stay with us. US stocks might have given back a fair chunk of the euphoric gains of Friday, but we played catch-up over here. Anywhere between 0.75-1% of gains were seen across Europe even though they ended off the day’s highs. And in the government bond market, it was about gaining back some of the losses of last week too. Bonds rallied hard with 10-year Gilts, Bunds, Bonos, BTPs and so on all seeing yields down 10bp or more.

Subdued secondary… The secondary markets were quiet as suggested earlier and spreads a touch wider for choice. The Markit iBoxx IG corporate index ended 0.5bp weaker while the HY index was up a little more at B+473.5bp (+7bp). iTraxx outperformed with Main and X-over lower at 71bp and 292bp, respectively.

Happy 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.