27th October 2019

QE to preserve fixed income performance

MARKET CLOSE:
iTraxx Main

50bp, -1bp

iTraxx X-Over

226.8bp, -2.5bp

🇩🇪 10 Yr Bund

-0.37%, +3bp

iBoxx Corp IG

B+114.3bp, -1.4bp

iBoxx Corp HY

B+404bp, unchanged

🇺🇸 10 Yr US T-Bond

1.80%, +4bp

🇬🇧 FTSE 100 6049.62, (+0.76%) 🇩🇪 DAX 12489.46, (+1.15%) 🇺🇸 S&P 500 3152.05, (+0.61%)

The damned sticky plaster…

It might appear fairly gloomy, but for fixed income we’re in decent shape to see a good run into year-end. The sell-off in rate markets in October has run its course. Meanwhile, Draghi has gone – leaving the Eurozone (as ever) on the brink of a deflationary spiral, struggling to generate any meaningful growth with the central bank clearly short on effective firepower. Lagarde is in – but running out of bullets, not that it is in any way going to deter her from trying more of the same, in a case of ‘not on my watch’. Unfortunately, the central bank has long been firing blanks. Poisoned chalice? Yes, it’s looking like the cycle is over.

Brexit still lurks, with the earnings season having been extremely mixed, the trade talks having stalled (hopefully some kind of a truce?) – or at least we have little information as to where they are at the moment, the Middle East tinderbox threatening to erupt and global growth continuing to slow. Fixed income in some areas has had a surprisingly weaker October versus what went on before, but we believe the rate market unwind has gotten ahead of itself. November and December should be more kind.

Risk asset markets have wavered at times these past few weeks. Uncertainty and event risk dynamics have seen to that. There has been plenty for investors to chew on. But with the ECB doing its best to once again manipulate the markets from the end of the week, adding €20bn of b0nd purchases per month, the initial market reaction is going to be interesting.

It is not a foregone conclusion that we will go lower in yield (rate markets) or tighter in spreads (credit markets) as a result of the QE intervention. Curiously, there doesn’t seem to be much evidence of front running right now. If there was, the 10-year bund yield, for instance, would be lower than the -0.37% it is now. In credit, IG spreads have edged better in the past week, but the high yield market has underperformed. Admittedly, the high beta AT1 market has been bid only, squeezed tighter and returns are closing in on 14% for the year to date.

As an attempt at an explanation, macro weakness and rich secondary valuations might be dragging on the high yield market. In primary, we have ‘expensive’ deals (low coupons) and ‘cheap’ deals (high coupons, close to 10%) in the market, but few in the ‘middle’.

It’s as if there is a yawning split in the market: a corporate either has it, or it doesn’t, as such. Still, we’re getting deals, the pipeline is looking sprightly and we are in course for the second-best year ever for this market. Vivion Investments was the sole borrower on Friday, adding €300m in a 6-year to the high yield tally (now at €56.5bn year to date) and priced to yield 3.75%.

Confused as to why secondary isn’t doing its thing? Yes. Maybe that will change once the ECB starts crowding out IG players from their market.


Records there to be broken

It’s that time of the year where we start to look at performances more carefully. And after the kind of year that investors have had, records beckon. The S&P is just 5 points away from a fresh record high. The Dow is less than 2% away from a record high. Rates have returned around 10% this year and credit at 7% in IG, or almost 14% for the AT1 market.

Credit primary in IG non-financials is a handful of deals away from a achieving record high, the senior market is about to deliver its best year since 2016 and high yield issuance is just €6bn away from recording its second-best year ever. For credit primary, November will deliver on all of those.

Hopes of a trade pact between the US and China propelled US equities into record territory with the indices adding around 0.5%. Europe was more mixed and eventually closed flat.

In rates, the risk-on tone pushed markets weaker, and yields rose across the board. In the 10-year, the Gilt yield was up at 0.67% (+5bp), the Bund yield rose to -0.37% (+3bp) and the US Treasury to 1.80% (+4bp).

Credit squeezed once again in IG, with the iBoxx index at B+114.7bp and now at the tightest level since July. The tightest level on the index this year is B+107bp and we will possibly push on it come next week, as the ECB starts to lift the market. The AT1 also squeezed some, the index 8bp tighter at B+438bp in the session, or 270bp year to date.

The high yield market isn’t feeling the same level of love as those markets. There is little interest to chase it at the moment, and the index closed unchanged at B+404bp.

As for this week, the FOMC is up on Wednesday/Thursday, with a rate cut of 25bp expected – leaving US markets to tread water until then. The non-farm payroll report for October (expected 90k additions, 136k last time) might help keep the rate markets subdued all week. Brexit will dominate in the UK markets with the government continuing to push for a December 12th election and awaiting the EU’s response to a Brexit deadline extension.

Have a good day.

Suki Mann

A 30+ 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 CreditMarketDaily.com.