- by Suki Mann
|iTraxx X-Over Index
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY Index
|10 Yr US T-Bond
Just do it…
An upbeat non-farms print completed an otherwise difficult week for markets. There’s likely more angst to come. With reflationary fiscal policy around the corner and having had GDP revisions higher in the US for Q3, the Fed appears to have little choice but to raise policy interest rates this month.
They have been itching to do so for months. The Fed will, in our view, overlook the unexpected fall in the wage growth that accompanied that NFP report (a drop of 0.1% in November month-on-month, versus expectations of +0.2%, but against a rise of 0.4% in September). Nevertheless, it was that wage growth number which set the cat amongst the pigeons, giving rise to some that maybe the Fed won’t move. Or that next year’s rate rises will be fewer and far between. Who knows!
So much so was the uncertainty, that the big rises in global bond yields on Thursday were dramatically reversed in Friday’s session as the market actually panicked. Short-covering or a scramble to get long? Two-year Treasury yields dropped 5bp, 10-year USTs 6.5bp and they dragged yields lower here. The 10-year Bund yields fell to 0.28% in another 9bp move (was 9bp higher the previous session), while the equivalent Gilt yield dropped 12bp to 1.38%. These are massive moves for a supposedly lumbering, risk-free asset class. Furthermore, how these two bond markets play out will depend on how returns will play out for this year.
With a month to go, the erosion in debt prices these past few weeks have had a marked impact on returns for fixed income investors although from a spread perspective, the sterling corporate bond market has fared better than the euro-denominated one. Returns in sterling corporate (at over 9% YTD) are also more than twice those of euro-credit.
Anyway, that all important Italian Senate reform referendum was held overnight but the likelihood of a “No” vote coming out tops didn’t deter the rush for BTPs at the end of last week (unless it was just short covering which prompted the ratchet higher in prices?). That’s because 10-year BTP yields dropped 15bp (!) to 1.90%, leaving them as the session’s outperformers. At the time of writing, the result is unknown (Austrian presidential elections too), but we are potentially set up for a very choppy period for the markets.
Rounding up, the corporate bond market saw a couple of high yield deals with Thomas Cook (upsized to €750m) and Catalent (€380m) seeing off the week for non-financial primary issuance. It’s not been such a bad start to the month, with €2.1bn of IG non-financial supply followed by that €1,130m from the HY market in the opening two days.
This week and next – up until around that Fed meeting on Dec 14th – is all we have left to get any deals away. How much will depend on the level of any volatility, investor sentiment and the prevailing tone once we get the final results of those two polls.
Crucial December for credit, performance-wise
Secondary IG corporate bond spreads closed a little wider at the end of last week, the cash Market iBoxx index up at B+139bp (+1bp) – but a basis point tighter for the week as a whole. Sterling markets closed unchanged. The rally in government bonds on Friday failed to elicit a better tone in credit, with our market failing to get carried away with big moves lower in government bond yield by grabbing a higher yielding asset.
After all, such has been the volatility of late, the moves are all too easily reversed. The high yield market did very little too, spreads on the broad index (iBoxx) just a basis point wider at B+452bp. iTraxx Main was down at 78bp (-1bp) and X-Over at 332.5bp (-6.5bp).
The issue for corporate bond market investors is rates. Higher yields potentially come on the back of higher growth and inflation (expectations). Higher growth ought to eventually lead to a recovery in corporate profits and so stocks will go higher. The credit to equity rotation trade kicks in. Ouch! We think that there is a possibility of that in 2017 but not before we are assured of that growth/inflation dynamic and yields look like they’re going higher permanently. Before that happens, we are seeing outflows as some run scared (and are protecting performance) of higher rates – on the back of that expansionary US fiscal policy to come, as well as the impact that is having on their fixed income returns (government bonds and credit).
Should the weekend’s votes go against “the establishment”, traditional safe havens might be better bid (Bunds, Treasuries, Gilts) while the rest will come under pressure. OATs might decline (in price) as markets fret about France’s political direction, while Italy and the rest of the periphery is sold in a flight-to-quality trade. Credit spreads will weaken as a better offered market sees little Street (or investor) interest to add any “cheaper” emerging risk.
Total returns for IG credit are at around 4% YTD. That would represent a very good level of returns in IG corporate bond markets in any given year. We’re irked because they were up at over 6% just a couple of months ago. Spreads have tightened only 14bp now this year, having given up some 20bp from the tights – and most of that weakness came in November.
There is a non-trivial probability that we give the rest of 2016’s spread performance back in the next couple of weeks – despite the ECB’s heavy lifting of corporate bonds from its corporate QE programme, where last week’s purchases will be known later today. It does feel like the current path of least resistance is lower and wider, respectively.
Let’s see how the day plays out. Have a good one!