25th April 2016

Divine intervention

MARKET CLOSE:
FTSE 100
6,310, -71
DAX
10,373, -62
S&P 500
2,092, unch
iTraxx Main
73bp, +5bp
iTraxx X-Over Index
310bp, +18bp
10 Yr Bund
0.23%, -1bp
iBoxx Corp IG
B+140bp, -3bp 
iBoxx Corp HY Index
B+479bp, -7bp
10 Yr US T-Bond
1.89%, +3bp

God only knows…

We potentially have the biggest ever player about to rock up, in price insensitive fashion, lifting what He can of the IG rated non-financial corporate bond universe. And He can do it for an indefinite period. It’s a meddling nuisance and we can argue the small print for ever and a day: sector risk, credit risk, event risk and possible jump-to-default risk – and management of it all. How much could He possibly buy per month? Cima_da_Conegliano_Draghi_the_FatherWill it be the nirvana finally needed to open up the funding transmission mechanism for SMEs so sorely constrained by the lack of cheap capital required for investment and expansion? But most of all, did He really need to get involved?

Unfortunately, He has, and as ever, the investment community will be looking to see how best to benefit from it. From a performance perspective, everyone should be better off. Even bonds not included in the purchase programme universe as laid out last week will get a lift from “crowded-out” investors needing to add risk (if only to play catch-up). The purchase programme’s universe of directly eligible debt will crunch tighter first, but the rest will soon follow.

And therein lies the real opportunity as the ECB has created – temporarily anyway and in relative terms – more low-hanging fruit. That is, a bunch of relatively cheaper and perhaps more liquid bonds, ripe for the picking. We would say not to worry about sector positioning – after all, there is no economic cycle. We’re just drifting along some sort of bottom. The name of the game while policy remains as accommodative as it is is still to take on the highest beta risk your portfolio constraints allow and perhaps to max up on off-benchmark paper and extend credit duration. Oil-related and other commodity groups might not have been in vogue, but their debt will also be swept up by the wave of players needing to get risk on board. That is, we’re going to have to become more pragmatic and forgiving, while tolerating some potentially issuer-specific volatility.

But the omens are good

The net result leaves us to believe that we are still looking to see the iBoxx index down at B+100bp versus B+140bp now, and it ought to come before the year is out. The Markit iBoxx IG corporate bond index moved another 3bp lower in the final session last week to close at B+140bp – its lowest level for 2016. That’s a weekly tightening of 9bp and takes returns YTD to 2.8%, with a week to go before we close out the month. The index is 15bp tighter for the year so far. All bonds have been in the ascendancy, but high beta risk has been the clear out-performer, with CoCos and corporate hybrids especially well bid. The index yield on the former dropped 50bp last week, while corporate hybrids fell 30bp to 3.76%. That is still almost 120bp off the low we saw earlier last year, and highlights how much further we can go price-wise for this hybrid asset.

Not to be outdone – far from it – the high yield market has also made an excellent recovery. There’s been little supply and fewer negative headlines, while the US market has also recovered. So we have squeezed tighter and the index yield has dropped almost precipitously to 4.57%, the lowest level since August 2015. Returns, languishing at around -2% in the YTD to mid-Feb, are now up at a quite stunning 3.5%, as measured by the Markit iBoxx HY index. We never believed the European HY market was bust and ought not to be affected by contagion risks from the US market given the different economic and monetary policy stages the two regions are in. Spreads at B+479bp on the Markit iBoxx HY index are 50bp tighter YTD.

Where have all the borrowers gone?

After a light week on the supply front, we only need another €4bn for this to be the biggest April ever for IG non-financial issuance. We would think that that target is achievable, although last week saw just €2bn of debt printed. Admittedly, the ECB meeting might have had something to do with that, but this week we have the Fed meeting and almost 200 S&P500 companies reporting. With the Fed expected to remain on hold, the market might be a little less nervous. Debt market participants have been very receptive to deals, as demonstrated by the level of demand for just about every transaction, seeing anywhere between 3-7x oversubscription.

For the month so far, we have only had €3.2bn of high yield issuance, and a paltry €8.9bn YTD. That’s very poor, but with yields dropping and demand for juicier deals evident, we think that the HY market ought to make something of a comeback. At this rate we will struggle to get anything upwards of €30bn for the full year – and it was in 2012 that we last failed to exceed that figure. There’s confidence again in US high yield, the ECB is distorting the market in favour of higher beta risk and the low level of issuance to date in 2016 ought to leave the market technically skewed towards borrowers getting deals away much more easily. We saw that last week. Senior financial issuance has exceeded €22bn MTD, with several deals each week keeping that market buoyant.

Month-end week, time to count chickens

There was an unusual, rather tired feeling to the market as we closed out last week. It was as if the ECB on Thursday had stirred us up into some kind of frenzy and then deflated us by not exceeding our expectations on the corporate bond purchase programme details. This week the US reporting season hots up, we have GDP numbers out and it’s month-end. We look for €4bn+ of non-financial issuance and for that monthly record. We also expect secondary spread levels to grind a little tighter, but how much might depend on any volatility elsewhere.

It’s been another good month for the markets where performance for credit market total return and benchmark players have excelled. Main and X-Over closed out considerably weaker at 73bp and 310bp, respectively, highlighting their underperformance versus a technically supported cash market. There was moderate weakness in European equities into the close while the S&P was flat and oil up 1.3% with Brent at $45.

Have a good week.

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.