21st Nov 2016

Quick, find me a short

MARKET CLOSE:
FTSE 100
6,776, -19
DAX
10,665, -21
S&P 500
2,182, -5
iTraxx Main
82bp, +2.5bp
iTraxx X-Over Index
348bp, +6bp
10 Yr Bund
0.27%, -1bp
iBoxx Corp IG
B+138.75bp, +3.75bp 
iBoxx Corp HY Index
B+446bp, +6bp
10 Yr US T-Bond
2.35%, +5bp

Party ends for fixed income…

party-over

Fixed income: Party’s over, folks

Interest rate volatility and the relatively heavy new issuances are weighing on performance and sentiment for credit investors, amid increased trepidation that comes with year-end dynamics. It’s just poor timing. That is, it is a tough call to add risk here through secondary amid that uncertainty, although we can see that they if they are – it is through primary.

More than a few are looking to reduce risk to increase cash balances for potential outflows or for new deals is meeting fierce resistance. That is, no bid or a poor bid. They’re lifted only if the other side is filling a short. Even asking for a bid for low beta risk (front end, highly rated) is meeting with the investor being looked upon as “persona non grata”. Trading desks are not interested. Hence the spread weakness – which has resulted in some low to mid beta issues up to 20bp wider from September levels.

Fingers crossed that the current (moderate?) outflows don’t materialise into a more serious, torrent of selling cares because the 12bp or so of Markit iBoxx index spread weakness last week will pale into insignificance against what will occur. After such a fantastic period from March to even the end of October – where returns for the asset class in IG and HY sat at well over 5%, November’s weakness has hit performance and the worry is that there is more to go.

The opening three weeks of the month have seen returns of -1.2% for IG corporate credit (Markit iBoxx) and spreads wider by 16bp in the month. Last week they moved 12bp wider and 3.5bp of that was on Friday. YTD returns for IG are now at 3.9%. The omens are not great, but the moves are entirely technical and can hammer the markets more… much more. After all, it was technicals and fear (of macro weakness) that got us here in the first place.

Well, it might not be so good for IG markets, but high yield returns are down 3% in the month to date. Spreads moved 6bp wider in Friday’s session and some 22bp wider in the week, as measured by the iBoxx cash index – that’s 37bp wider for the month. There have been outflows and the impact of those outflows is disproportionate as far as valuations are concerned for this more illiquid market. The deal backlog is massive, it makes us wince almost as to how spreads might evolve if borrowers become price takers when those deals are printed.

Sterling investors will be sitting a little more comfortable if benchmarked, given that spreads moved just a basis point wider on Friday and just 3.5bp last week. However, returns have dropped -1.8% for November thus far owing to the weakness in Gilts. Returns year to date for sterling corporate are now at 8.3% YTD, over 50% lower than the peak (17.2%) seen in August. That will hurt, but 8.3% total returns (or anything over 6%) are excellent for this market.

And all because the people wanted change

It seems that interest rate markets are going to continue their domination of the market’s moves and investor sentiment. The Treasury market is leading the way with the 10-year now yielding 2.35% (+5bp on Friday) – leaving 2s/10s steeper at 128bp and the Treasury-Bund spread at a massive 208bp.

The basic message is that the fiscal spending taps are going to be turned on in the US, that Europe will continue to chug along at this low growth trajectory and we have rate/policy/growth divergence between the two regions. Treasury yields will therefore stay higher and (for once) not necessarily drag Bund yields higher with them. IF that is the case, the corporate bond sell-off is overdone in Europe.

Politics is going to be our bogey. We have the Italian referendum on constitutional reform coming up on December 4. Once over that, we look forward to French elections and then German ones. Q2 and Q3 next year will be interesting periods for the markets. More immediately, the corporate bond market can recover some of its recently lost performance, although it seems that few are willing to chance their arm and prefer to keep a defensive mindset (no secondary, reduce some positions, add in primary).

Should we get a catalyst for a broad recovery in the next week or so, we would think that Italian risk will underperform into that recovery – for obvious reasons.

Primary promises much ahead of Thanksgiving

After you , sir....Black Friday rounds off the week.

After you , sir… Black Friday rounds out the week

Deals have been getting away seemingly with ease. After all, they’re oversubscribed 3x or more and pricing is nearly always tightened by the obligatory 10-20bp versus the initial guidance levels. We have been surprised that more issuance from European borrowers hasn’t emerged and certainly do not believe that there has been any noticeable increase as a direct result of the ECB’s QE programme.

So far this month, we have had €16.6bn of IG non-financial issuance, with €9.15bn of that issued last week. Our expectation at the beginning of the month was for €20-25bn of issuance and we think that is about where we will end up. The main business will get done Monday to Wednesday as we think the market will look to quieten down into Thursday’s US Thanksgiving break with little happening on Black Friday.

There has only been €2.5bn of issuance from the HY market in November, but the pipeline is jammed, after road shows galore. Should conditions allow (risk on, that is), then we could get 2-3 days of heavy supply. Otherwise, these borrowers will have to wait until next week.

This week is all about Thanksgiving, Black Friday and the UK Chancellor presenting his Autumn statement (on Wednesday). Should all be easy to get through. Have a good start to the week – back again tomorrow.

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.