24th November 2016

One of those days

MARKET CLOSE:
FTSE 100
6,818, -2
DAX
10,662, -51
S&P 500
2,204, +1
iTraxx Main
82bp, +2bp
iTraxx X-Over Index
345bp, +5bp
10 Yr Bund
0.26%, +4bp
iBoxx Corp IG
B+138.9bp, -0.5bp 
iBoxx Corp HY Index
B+444bp, -5bp
10 Yr US T-Bond
2.36%, +5bp

Rewriting economic theory…

Unprecedented times: New thinking needed

Unprecedented times: New thinking needed

Since when did we ever get a sustainable period that when government bonds sold off, equities did too? Surely, what’s good for one is bad for the other? Of course, the crisis years have savaged classic economic theory and expectations of linkages between markets have altered. Mass manipulation by central banks taking in unprecedented levels of QE and loose monetary policy hasn’t quite worked out the way it ought to have, and now see the two biggest asset classes move in tandem.

In yesterday’s session, a Trump-esque like Autumn statement from the UK Chancellor – unleashing the fiscal dogs on infrastructure spending – meant that Gilts took a battering. Actually, Bunds did too – as did peripheral governments.

Those higher yields automatically translate into reduced liquidity (for example, through the higher cost of funding), a squeeze perhaps on corporate profits and a headache for the ECB (and the BoE). Rates are at rock bottom levels and QE ongoing, and yet little sign of a pick-up in capex and investment or confidence. The so-called transmission mechanism isn’t quite working how it should.

At least the UK government is giving it a go, albeit belatedly at that, not constrained by the Maastricht rules but still reliant on an expectant and judgemental market. In the Eurozone, they’re in need of trying trying something different – structural shifts in policy – and a need to bend rules which hitherto have fairly rigidly been enforced. So we think the ECB will keep policy as it is and likely announce in December that it will extend QE for a minimum of a further six months so giving some credibility to Draghi’s famous “whatever it takes” words from a few years ago.

The opening story for the session might have been around those 2-year German bond yields being in record low territory – but they didn’t hold those levels. For a moment, it looked as if a Thanksgiving-lull had set in, as all government bonds rallied but then we had bit of a sell-off (as mentioned above). Losses in equities also accelerated into the afternoon session. That seems to have come on the back of surging US durable goods orders for October as well as some upbeat German service sector activity in the same month. It’s leaving equities fearing higher yields (and higher US interest rates) while government bond investors are wondering whether the era of low market rates are sustainable for much longer (QE or not).

Thanksgiving blues

Heading into today’s Thanksgiving U.S. break, we’ve endured a choppy couple of weeks, while even yesterday’s session was volatile. Equities closed out around 0.4% lower in Europe while those in the US dropped less despite those good orders. The 10-year Gilt yield rose to 1.45% (+9bp) and some 85bp off the post QE/Brexit lows. The 10-year Bund yield also rose – to 0.26% (+4bp), with debt underperforming in the periphery as Italian referendum jitters resurfaced (what else?) leaving BTP yields back higher at 2.11% (+9.5bp) followed by Bonos (+7bp higher to 1.59%).

If not Trump’s anticipated economic policy, then the recovering US economy as evidenced by the durable goods report saw to it that Treasuries took a bit of pain. The 2-year is now yielding 1.13% and the 10-year 2.37% in seems a nailed-on certainty that the Fed will be raising rates in December.

The Thanksgiving break will give us all a rest!

Four weeks of trading left to hang on to performance

ASML is a Dutch company and currently the largest supplier in the world of photolithography systems for the semiconductor industry.

€750m deal: Dutch firm ASML is a major supplier to the semiconductor industry

We had a couple of deals in IG non-financials, more mandates being awarded and roadshows announced as well as some financial issuance. We’re either going to have a very busy 2-3 weeks before we close out come mid-December, or these deals are going to open 2017 with a flourish.

The deals in yesterday’s session came from Adecco for €500m in an 8-year maturity and 20bp inside the initial guidance. That pricing dynamic was bettered by ASML which raised €750m in a 10-year deal – and a stunning 25bp inside initial guidance. And we’re supposed to be wary of the rising yield environment, apprehensive about where spreads might be heading and in some cases, taking some chips off the table! That’s not the case as evidenced by these deal dynamics.

But it is the rising yields environment which is preoccupying corporate bond investors. We’re not piling in on the back of the better valuations, despite the demand for primary risk. IG corporate markets were better bid, but the moves were really noise in the big picture, and evidenced through just a 0.5bp of tightening in the Markit iBoxx corporate bond index. There was also some recovery in the HY market, with the cash index down at B+444bp (-5bp).

The sterling corporate bond market didn’t react to the vagaries of the autumn statement by the UK Chancellor, but Gilts selling off was enough to cause the damage. The cash iBoxx index closed unchanged at G+160bp, but returns fell on the weaker Gilt move. With the BoE still lifting bonds as part of their corporate QE programme, there’s a good chance that benchmark investors will come up trumps, but total return players might be looking at something in the order of 7% of performance for the year – versus 17.2% three months ago.

And finally, the iTraxx indices widened with Main closing at 82bp (+2bp) and X-Over at 345bp (+5bp). Risk off.

We will be back tomorrow. 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.