25th February 2020

😨 Pandemic of Fear

MARKET CLOSE:
iTraxx Main

50.3bp, +2.4bp

iTraxx X-Over

243.8bp, +11.3bp

🇩🇪 10 Yr Bund

-0.52%, -4bp

iBoxx Corp IG

B+109bp, +5bp

iBoxx Corp HY

B+363.5bp, +11bp

🇺🇸 10 Yr US T-Bond

1.31%, -6bp

🇬🇧 FTSE 100 6032.85, (+2.29%) 🇩🇪 DAX 12646.98, (+2.71%) 🇺🇸 S&P 500 3271.12, (+0.81%)

Closing off the world…

The high level of price volatility is a pure reflection of the fear and uncertainty plaguing the market. A case of ‘what if?’. After a bright start, the markets slumped and any early attempt to drag themselves off the floor proved short-lived.

And that brighter opening came even after German economic growth for Q4 showed an economy having stagnated, registering 0% for the period – and surely going to record something negative for Q1.

The resistance was futile as the coronavirus-yet-to-be-called-pandemic remained at the forefront of most minds amid growing concern of the increased cases across Europe. The financial markets’ Black Swan event? It’s back in view.

As if to highlight how difficult it has been and what we might look forward to, Hong Kong’s imports dropped by over 16% in January and exports declined by more than 22%. It was an eloquent demonstration of the devastating impact of the virus and how regional trade is being affected by the spread of it. The Chinese data is going to be awful for the month/quarter/half, just as it will be for all of Asia.

With more areas of Italy in lockdown, the Middle East feeling greater strains and the likelihood of further lockdowns across Western Europe, then a domino effect is in play which will see those economic activity numbers (output, productivity, growth) slashed for 2020, let alone the quarter.

Nevertheless, it’s quite clear that the markets want to go higher and any whiff of containment of the virus, they will recover much of the current losses, we believe. And that will be after taking into account the extended period of any hit to economic growth, corporate earnings and the readjustment of the corporate sectors’ investments as they possibly look to re-shore activities after decades encompassing a more globalised approach.

Sell and kiss ’em goodbye

In credit, sell into the eye of the storm and come back once it has passed to rebuild positions? It’s logical. But we wouldn’t.

To do so would illustrate a non-appreciation of the dynamics of the corporate bond market. And it is all centred on liquidity – or rather the lack of it and why this is so.

Admittedly, equity weakness weighs. The fear of the unknown promotes many an itchy finger. There’s nervousness that corporate credit quality is going to deteriorate and certain sectors are going to be impacted more than others – hence a temptation to reduce, hoard cash however painful that might be and/or switch into safer sectors (however difficult that might be!).

The problem that investors will encounter is that there is the poorest of bids (if any) into weakness and reduced offered-side liquidity (if any) when we’re into the recovery phase. That is, a significant inability to trade efficiently and effectively. Sell and one kisses those corporate bonds goodbye.

And that’s why we are witnessing what we believe to be exaggerated moves in spreads, especially for the more illiquid instruments/sectors – CoCos and high yield debt. Some of the moves might be warranted based on macro weakness reasons impacting credit quality more in these sectors, but we are far away from disaster in them.

We would be inclined to hold fire for now. Lock-in periods will render that necessary anyway and prevent a ‘rush for the exits’ dynamic crushing the credit market. Portfolios should be able to withstand some moderate levels of rating transmission risks as well as the volatility and spread weakness we’re seeing right now. If anything, adding a bit of credit protection would be the way forward.


Pummelled – again

After a bright start, we had a significant reversal. In fact, we’re in slump territory. Gains of 0.5% or more across European equity markets turned into losses of up to 2% – largely on the back of weakness again at the US open.

The obvious trigger was the fresh cases of the virus’ spread across Europe which are clearly leaving a fairly nervous investor feeling a more nervous and trading the unknown. Up to 1000 tourists in Tenerife were reportedly quarantined, for example, during the day in one of the bleakest of breakouts.

So, equities tumbled by 1.9% for the FTSE, the Dax lost the same and the €Stoxx50 over 2%, while the level of those losses was replicated across much of the region. US equities were off by 1.2% as at the European close, but losses accelerated thereafter and the indices were off by up to 3% at the time of writing!

Sanctuary was sought in rates. Benchmark yields plummeted again with the 10-year US Treasury dropping to 1.31% (-6bp, at the time of writing and incidentally a record low), the Bund yield at -0.52% (-4bp) and the Gilt yield down at 0.51% (-3bp). There was no upside for gold, though, the precious metal lower by all it gained in the previous session, off by $25 at $1650 an ounce.

Primary credit was closed save for the Spain sovereign deal and a surprising Paccar offering. The latter issued €300m in a 3-year at midswaps+27bp, and Spain issued €5bn in a 2050 maturity transaction priced at midswaps+86bp off an €18bn book.

The synthetic credit indices moved higher as credit protection was bid up. iTraxx Main rose to 50.3bp (+2.4bp) and X-Over by 11.bp to 253.8bp.

The cash market was also weaker, and as much as it was on Monday! The IG iBoxx index moved to B+109bp (+5bp) and is now 4bp wider year to date (total returns still easily positive as the underlying has rallied hard).

We saw more moderate weakness in the AT1 market, the index just 12bp wider, versus 33bp in Monday’s session. It was the same in the high yield market, with just 11bp of widening in the index to B+363.5bp, against 25bp in the prior session.

Probably a bit late as a useful distraction. On Thursday, we have the UK’s negotiating proposals on Brexit to look forward to, following on from the EU’s proposals on Tuesday.

In the meantime on Wednesday, it’s going be another quiet session primary, and all markets will remain focused on the coronavirus’ developments. We will in part be playing catch up to the late equity market losses in the US (3% or more), at our open.

Have a good day.

Suki Mann

A 30+ 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 CreditMarketDaily.com.