1st February 2016

Purple Rain

MARKET CLOSE:
FTSE 100
6,084, +152
DAX
9,798, +159
S&P 500
1,940, +47
iTraxx Main
91bp, -2bp
iTraxx X-Over Index
365bp, -8bp
10 Yr Bund
0.32%
iBoxx Corp IG
B+174.3bp, -1bp 
iBoxx Corp HY Index
B+596bp, -7bp
10 Yr US T-Bond
1.92%,

Boring is good, sometimes… The current macro conditions (low inflation, economic weakness, event risk, asset valuations and the like) play into fundamental support for the European corporate bond market. Parts of it will be and have been sullied by the oil/commodity theme. The demise of shale gas operators, for example, has been heaping pressure on the US high yield market and leaving devastating contagion on the HY market in Europe, which fails to operate in isolation from the US. Meanwhile, the commodities selloff has impacted some big borrowers in the investment- grade space like Anglo American and Glencore. There will continue to be sustained pressure on the corporate bond market in Asia, where over-stretched Asian corporates come under fire from dollar strength and the default rate is picking up aggressively. More contagion and worsening sentiment will again impact sentiment towards European HY, in particular – without there being any material pickup in the default rate. However, we are of the view that IG corporate debt generally ought to be able to ride the wave of the macro discontent. It has certainly played out this way in January, as judged by the positive returns of the asset class. There will be idiosyncratic situations that we are unable to position for but when they impact seriously large and important borrowers of Volkswagen’s ilk, or we get sectoral discontent like in the commodities sector, then the unwillingness to get involved is understandable. In addition to that, we have a poor liquidity situation which is unlikely to improve for years. There’s no point in pining for those pre-2008 “what’s your size… done” days; they are gone. We have become a buy-and-hold asset class, and gone back to basics of a cash market no longer sullied or complicated by the 2003-2008 derivatives era. We’ve grown almost exponentially through these crisis years into a Eur2trn corporate bond market. It’s time to heed to the successful rule of “Keep(ing) it simple, stupid”, or K.I.S.S. Preserving capital, enjoying the income and playing it safe – which means IG and solid double-B HY rated bonds are still a good way to park that cash. Corporate bonds were never meant to be exciting.

Kuroda kitchen sinks it…. The curveball thrown by the BoJ stumped us all at the back-end of last week, and highlights the escalating nature and sense of crisis in the global economy. The Japanese central bank has joined the negative interest rate club. The ECB previously pushed on that string much more hastily (as did the Danes and the Swedes). A deflation-sodden Japanese economy has finally forced the central bank to adopt negative interest after nigh on 20 years of severe economic weakness. The race to the bottom is on. Our view, in a nutshell: it won’t work. We think banks will continue to hoard cash just like they have been doing in the eurozone. This desperate but still rarely used classic economic response (textbook stuff) isn’t the way this global crisis is going to be solved. Still, it fed risk assets on the final day of a quite remarkable angst-ridden month, making returns look a little better – especially in government bonds and corporate credit – while giving hope that February will bring greater riches.

Corporate bond returns improve, helped by the BoJ move… Thank you very much (see charts)The imposition of a negative deposit rate on certain bank assets boosted government bonds pretty much everywhere. There was obviously also an element of month-end rebalancing mixed in with the rally in risk assets. The 2-year Bund yield saw a new record low of -0.49%, while the 10-year Bund revisited 0.32% after dropping 8bp (last seen in April 2015). Dare we believe in a new record low (sub 0.17%) for the 10-year? This could happen if the ECB wheels out its own shopping trolley in March. Anyway, Italian (1.41%, -10bp), Spanish (1.51%, -11bp) and Portuguese (2.86%, -10bp) bonds joined the party.

From a performance perspective, eurozone government bonds returned a super 2% in January, IG corporate bonds +0.5% and HY returns were less negative, improving to -1.65%. Equities were similarly boosted, but returns before last Friday were so deeply in the red that there was really little hope that they would return to more respectable levels. January has been particularly cruel to oil and equities, although the recent oil rally has seen the former recover to end the month just 4% down (Brent, $35.99) and way off the worst levels of -30% (below $27!), while the DAX was down 8.8% and the S&P off 5%. In all, the credit numbers just might help stem potential outflows from the asset class in February. This is important, because little else structurally will weigh on the asset class (we don’t even have much new issuance), and it might therefore aid some sorely needed spread recovery following much weakness in the opening month.

Corporate primary bursting at the seams, or just busted… Every syndicate will be signalling that there is a massive pipeline and that as soon as we get some calm in markets, visibility on macro and reduced volatility, the floodgates will open. They are most probably right. There is much demand for primary (main route to add risk), despite the lack of interest or inability to trade in secondary. It is in nobody’s interest to see a “failed or poor” deal. Issuers though will be wanting to display bravado and feel that they are not paying up to get a deal away. But investors will need performance and therefore demand a decent new issue premium to ensure they get it. Syndicates just need the fees. January was a particularly poor month (see charts) – one of the worst ever on aggregate. While little has really changed on macro and the level of activity is at the mercy of market volatility, we have to believe that February will be kinder to the primary sector. Eur5bn in IG non-financial issuance for a January is shockingly low. HY gave us less than Eur1bn, but that isn’t a standout number, while the Eur11bn in senior issuance is also a poor level of supply. It won’t take much to exceed those levels in February.

The news flow on Friday wasn’t particularly upbeat. We would say that even the BoJ’s administered medicine is too little too late for the desperately ailing patient. US GDP rose less than expected in Q4 – and was largely explained away by various commentators as a blip. Don’t worry, it will be better in 2016! Still, equities took this as a sign of a delayed hike in US rates, and rallied some more. The S&P closed out 2.5% higher, while the 10-year rallied, leaving its yield down at 1.92% (-6bp). The eurozone’s annual inflation crept up to 0.4%, but Spain’s was down at -0.4% in January, although its economy grew by an impressive 3.2% in 2015. We’re now into the thick of the European earnings season, so while some focus will be on the numbers, we think macro (non-farms wraps us up on Friday) and oil will have a greater bearing on market directionality. The Markit iBoxx IG corporate bond index closed out the month at B+174.3bp (+20bp in January) and the HY index at B+596bp (+68bp). Index yields fell on a combination of those better spreads and the Bund rally at the end of last week to 1.70% (-9bp in January) and 5.81% (+50bp), respectively.

On a housekeeping note, we have added returns and spread data pages to the site to help with your understanding of the corporate bond market, but also to help facilitate your decision making processes. Happy February, back in the morning.

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.