18th June 2017

Polishing the myth

MARKET CLOSE:
iTraxx Main

57.5bp, +0.4bp

iTraxx X-Over

238.2bp, unchanged

10 Yr Bund

0.28%, -1bp

iBoxx Corp IG

B+117bp, -0.5bp

iBoxx Corp HY

B+305.8bp, -0.5bp

10 Yr US T-Bond

2.15%, -1bp

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Still going on about high yield…

Intrum Justitia: €2.7bn deal on Friday

Another event-risk ridden week has passed us by and we closed it out on the front foot. But that’s when we look at it from an equity market perspective. From a credit viewpoint, the corporate bond market has been completely unfazed by the mixed macro news flow, the rate decisions, UK election and the volatility which has largely been felt in currency, equity and rate markets.

Credit spreads have ground relentlessly through them all and the high yield market (as we have written on several occasions now) and is swatting every potential banana skin aside. The record low level of spreads and yields – as measured by the iBoxx cash index – has materialised despite some big down days in equities. That is unusual given the close correlation – in these more extreme daily moves – between high yield and equity valuations.

And it’s not as if we haven’t had much issuance such that there ought to be reduced pressure on secondary. Nope. We have had €4.4bn of new deals last week (more than in IG!), and some €6.5bn this month so far – boosted by that €2.7bn blockbuster deal from Swedish credit management services and debt purchasing group Intrum Justitia on Friday. Intrum has recently merged with Lindorff.

With supply passing the €32bn mark YTD in high yield, this current run rate of issuance takes us into record-breaking territory for the year – if maintained. Usually, that would be a harbinger for some weakness in secondary, except that this time, macro is supportive, the default rate is non-existent (in relative terms), the rate environment is supportive, given the low yields on offer – and crucially, demand is high.

There’s cash to put to work in good (or otherwise) corporate assets as investors look for a bit of yield to prop-up their returns. Last week alone, the HY index tightened by 11bp and the returns for the asset class for index players comes in at 4% for the year-to-date. At B+306bp, the index is 107bp tighter since the beginning of January, and begs the question as to how much tighter can spreads get?

Remember, the ECB is still lifting nigh on €1.7bn as a long-term average of corporate bonds in IG – per week for 53 weeks now. Last week, we only had €1.5bn in supply in IG non-financials. Just from that simple technical alone, there is a supply/demand imbalance. And then we have IG spreads/yields offering scant reward for the effort. So, down the curve we go.

That frustrating but supportive backdrop from both a fundamentals and technical dynamic means credit is having it’s day in the sun. It is completely unexpected. We would have thought some rotation into equities from a multi-asset perspective would be occurring. It isn’t and not just because equities look super overvalued – one could argue credit risk is too.


Macro remains mixed

Weaker home starts in the US for May saw to it that the recent crop of mixed economic data from the US continued. Yields declined a touch everywhere on the back of it with the US 10-year off a basis point to 2.15%, the equivalent maturities in Bunds (0.28%), OATs (0.64%) and Gilts (1.02%) all followed suit. European stocks remained in the black through the session though, as US stocks experienced another mixed session and just managed to claw themselves back into the black into the close.

Primary markets in IG have disappointed last week, while the non-financial IG numbers so far this month are flattered only because of the €7bn AT&T deal. That said, the sterling markets have been very receptive to deals and not fazed by the political and economic dire straits the UK finds itself in.

AT&T took a billion pounds worth of debt and we had a high yield deal from Ocado which also met with huge demand (allowing pricing to be tightened considerably). It’s worth noting that Intesa was also in the markets on Friday as it lifted €500m in a 5-year maturity green bond issue.

For this week and next, we’re hoping primary picks up, because the €13.3bn this month of IG non-financial issuance isn’t satisfying anyone. Admittedly it is more than what we saw in both 2015 and 2016 (around 11bn each), but we are looking in the order of €30bn for the full month. The high yield issuance has been excellent and the pipeline is still very good, but we don’t think the sector will throw up more than €10bn in June.


Bang, Bang

It was better again as we served up a double-header into the close last week with spreads tighter in IG and HY. As measured by the Market iBoxx IG cash index, spreads tightened 0.5bp on Friday and 2.5bp in the week against just €1.5bn of non-financial issuance and just a few senior bank issues. We ought to see more performance (returns YTD at 1.3%).

But that crowding-out effect in IG is seeing the HY market do much better than expected. Even after that mass of issuance last week, the index showed that secondary tightened by 12bp to a new record low close on Friday of B+305.8bp.

It would seem that much investment grade corporate bond demand has necessarily shifted to the high yield market now. For the opening two weeks of June, spreads in high yield have tightened 23bp even with an above average level of issuance (for any full month) of €6.5bn.

It is obvious that some (many?) will be thinking in terms of valuations now being too stretched, and that a pullback of massive proportions isn’t far away. As we have stated on many occasions, we need a trigger for that – and not necessarily the obvious ones. In the meantime, it is about making hay while the sun shines.

The iTraxx indices didn’t do much at the back-end of last week, closing Friday’s session close to unchanged with Main at 57.5bp and X-Over at 238.2bp – and not far off multi-year lows. .

As for this week, there isn’t too much by way of macro to distract the markets. In the US it is homes sales data, while the Brexit talks begin in earnest on Monday. A modest risk-on week will have those high yield valuations break fresh records.

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.