27th June 2017

Now is not the time for fear – that comes later

MARKET CLOSE:
iTraxx Main

54.6bp, +1.2bp

iTraxx X-Over

237.5bp, +5.2bp

10 Yr Bund

0.35%, +10bp

iBoxx Corp IG

B+113bp, -1.2bp

iBoxx Corp HY

B+293.3bp, -6.5bp

10 Yr US T-Bond

2.20%, +7bp

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High yield, what else?…

In the corporate bond market, there really is only one area to focus on right now, and that’s the high yield corporate bond arena. And perhaps especially so after those comments from Draghi suggesting that the threat of deflation has gone and reflationary forces are at play. If so, and if with that comes a decent level of growth, then the early throes of that cyclical recovery (admittedly it might be out of sync with the US) will benefit the high yield market.

How come? Greater levels of economic activity means increased turnover and free cash flow which improves debt servicing and can usually boost cash balances. That is, credit metrics get a boost – an additional boost given that the crisis years have seen a massive reduction in debt costs as funding yields have declined. Second, the ECB will stay accommodative through this year and likely well into next plus perhaps beyond in some format.

So, the default rate stays low, confidence in the asset class stays high, rate markets don’t have yields going through the roof and there is no rotation out of fixed income corporate assets. That is, high yield investors in most cases are going to get their money back. The shift away comes when the cycle ends (rather, turns), downed police rates/market rates play catch up (go down again) with a lagging effect. The default rate goes up and high yield spreads widen sharply. This isn’t going to happen in the next two years unless the current Eurozone recovery dynamic is a massive false dawn.

But we can understand the nervousness around high yield valuations. Spreads and sector yields are at record low levels. But as briefly reasoned above, there is a method in the madness for that to be the case. And we are going to need to get used to that being the case as we go deeper into record territory.

We mentioned the US oil market might have a negative contagion impact here if the shale producers come under pressure like they did a couple of years ago. But once bitten, twice shy – and any material high yield weakness in the US market might see a more measured response/weakness in high yield spreads in Europe.

We can appreciate the nervousness in some quarters around valuations. It isn’t stopping them piling in, though, and adding through primary where supply is running at a level which might deliver a record level of issuance this year. In June 2012, the Markit iBoxx index yielded 10.32% off a B+990bp spread level.

Steady tightening and a decline in underlying yields saw that drop to 6.43% and B+668bp, respectively, in February 2016. Sixteen months later and well into the ECB’s QE corporate bond programme for IG non-financial debt, we have witnessed those levels collapse further to set new records – of 2.79% and B+293bp, respectively. Gulp!


Corporate primary draws a blank

Gecina: 3-tranche funding strategy

Against expectations, IG non-financials delivered a blank session on Tuesday. Instead, investors were consoled by REIT Gecina which became the latest join a long line of borrowers of late (two others this week) to opt for 3-tranche funding strategy.

The borrower’s takings totalled €1.5bn split evenly across a 5-year FRN and 10-year and 15-year fixed maturities with final pricing 22bp tighter (in all tranches) versus the opening pricing gambit. The only other deal of note was HSBC’s €1.25bn PNC12 AT1 offering priced to yield 4.75% versus initial guidance at 5/5.125%.

Other deals took in state-owned Deutsche Bahn in sterling (£300m, 8-year G+63bp), we had Essilor in the dollar markets along alongside a welter of SSA deals with Spain’s €8bn 10-year deal being the pick of the bunch (order book at €30bn). The lack of corporate deal flow perhaps gave investors a little time to digest last week’s €10bn of issuance and Monday’s €5bn of IG non-financial supply.

There was a solitary deal in high yield for €450m from Belden Inc (and EuroChem in dollars), but again no senior financial deals (and just €6bn issued this month so far).


Rate markets pressured by Draghi comments

Draghi’s more upbeat inflation assessment ate into rate markets and we saw a stunning back up in yields. For example, 10-year Bund yields rose 10bp to 0.35% and the 5-year to -0.32% (+6bp), 10-year OAT yields also pushed 10bp higher to 0.71% and even Gilts got taken up by it, the 10-year at 1.08% (+7bp). In the US, Treasuries for the same maturity were yielding 2.21% (+8bp).

Stock markets spent the session in the red and never threatened to break out into something more positive. So we saw small declines in equity bourses across all markets in a rather uneventful day for them. Even oil prices managed to rise by over 2% leaving Brent trading off a $47 per barrel handle as the dollar weakened and was trading close to $1.13 versus the euro.

And in the secondary credit market, we also had mixed reaction. Cash held firm while the synthetic indices followed the direction of equities (that is, protection costs rose). So in the synthetic space, iTraxx Main was 1.2bp higher at 54.6bp while we saw X-Over close up at 237.5bp (+5.2bp).

Investment grade corporate bonds were better bid, though, and the broad Markit iBoxx index was lower at B+113bp (-1.2bp) – to the lowest level of the year so far. Unfortunately, the back up in the underlying (government benchmarks) meant that returns fell, sharply. Sterling credit risk was similarly bid, the index lower to G+134.8 (-0.5bp) – and the tightest level since Q1 2015.

As for high yield, another major squeeze saw the iBoxx cash index down at a new record tight of B+293.3bp (-6.5bp). Enough said.

Have a good day.


For the latest on corporate bonds from financial news sources, click here.

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.