30th August 2016

Race to the bottom still on

MARKET CLOSE:
FTSE 100
6,838, closed
DAX
10,544, -43
S&P 500
2,180, +11
iTraxx Main
67bp
iTraxx X-Over Index
307bp
10 Yr Bund
-0.05%, +3bp
iBoxx Corp IG
B+120bp, -0.25bp 
iBoxx Corp HY Index
B+421bp, unchanged
10 Yr US T-Bond
1.57%, -6bp

Ready, set, go man go…

We’re back after the break, with all markets (actually) in very good shape. Corporate bonds have performed well, offering some excellent performance year-to-date. Government bond markets have held up well, too, as yields remain at or around record lows. Equities have had a super month with indices at year highs, close to record highs or – in the case of the DAX – clawing back much of their 2016 losses. Oil has had a better time of it of late too. What’s driving it? For European corporate debt – it’s central bank QE activity and the low yielding environment seeing investors look for a fixed asset offering a relatively decent income stream.

Race-to-Bottom

Race to the bottom for some assets

In addition to that – and for everything else – it is about an economy not blowing too hot or too cold. We’re pretty confident policy stays accommodative, and perhaps even becomes more accommodative. Playing into that means equities look attractive still, government bonds stay anchored or prices edge higher from here (yields lower), and corporate bonds continue to perform. For some assets, it’s a race to the bottom.

We’re set up for the traditional run-in, and the home straight doesn’t look as daunting as it might. We think that September could be a good month, especially if:

  • the Fed stays pat
  • the ECB suggests further easing to come (later in Q4?)
  • we get enough issuance with good performance which then keeps participants upbeat
    • and which then leaves confidence on a high.

Spreads, as measured by the Markit iBoxx IG corporate bond index, are 25bp tighter YTD, 70bp off their February wides and are heading for B+100bp (currently at B+120bp). The HY market has had a consistent tightening trend of late and spreads there are at their lowest levels of the year (measured by cash indices) as is the index yield. In fact, they are 100bp and 150bp lower, respectively, year-to-date.

It seems that the crowding-out effect from the ECB is seeing some upside to this market, although we admit there has been little news flow to disrupt the recent rally in higher beta credit. Oil is holding at around the $50 per barrel area, as concerns around the US shale brouhaha has faded for the moment which has helped HY in the US allowing a more calming impact on HY in Europe.

Also, the latest data suggests that inflows into the corporate bond space continue – they have even accelerated – with investors looking for safety, capital preservation and an income stream. After all, who wouldn’t be licking their lips at the kind of high level of returns seen so far this year. We are up at year-to-date total returns of a remarkable 6% for € IG corporates (Markit iBoxx index), we’ve seen a great recovery to 7% in € HY and a Brexit QE inspired whopping 16% for the longer duration £ IG corporate bond market.

Of course, it is understandable for those wanting some of the action in these market. Admittedly, and a word of caution – that past performance is no guide as to how it might work out going forward!

The risks build, but they have been building for years

The fuel boosting this current risk-asset rally has come from QE, the potential for further easing, the likelihood of accommodative policy being extended, and finally – the belief that there will be no cataclysmic event derailing the global financial system.

We don’t play into the view that the risks to a corporate bond market sell-off are imminent, nor do we believe that government bond markets are on the last legs of their own rally. There are some signs of higher inflation but we have been through many a false dawn over these past eight years on that and many other fronts, and it is hardly as if the data is coming off a high base. The data as such has also been very mixed – albeit slightly better than expected – of late, but again we don’t buy into there being some kind of green shoots of an economic recovery. The Eurozone economy will plod along its low growth path for a good while yet.

However, the numbers do tell us that corporate and government bond positioning is a crowded trade, and what hurts most will be a major sell-off. But much of why yields and spreads are at these historic low levels is because of QE and that difficult economic environment (too much debt, high unemployment, fear, low inflation). QE purchases are just a form of market manipulation which has left 10-year Bund yields at -0.05% while the BOE’s efforts have pushed Gilt yields to 0.57%. These are off the record lows, but have been driven down by the central banks’ heavy lifting.

Spanish and Italian government bond yields are similarly close to record lows which were set only a couple of weeks ago, while Portuguese risk has gone the other way and sold off on recovery and deficit fears.

There will be periods where we sell-off, where the data will surprise to the upside and where we will question whether the inflexion point has passed to some kind of glorious economic recovery. Any opportunities which arise from this (weakness in government bonds and corporate bonds) should be seized.

The ECB’s bulging shopping trolley

It was a Monday, and that meant the latest publication of the ECB’s shopping receipt. €1.5bn of IG non-financial corporate bonds were accumulated last week, or €19.3bn in the eleven weeks since the corporate bond QE operation began. That is a small decline on last week’s €1.6bn – but admittedly, still somewhat of a surprise that they could lift so much into the biggest holiday period of the year (€3.1bn in two weeks). The weekly average declined a touch but still sits at an impressive €1.76bn. There is going to be a greater impact on valuations (tighter spreads) very soon and do remember that the bonds that the ECB purchases will never re-emerge.

ECB weekly corporate bond purchases

All eyes on issuance

Issuance for the month as we enter the penultimate session of August leaves IG non-financial supply at €5.3bn, high yield issuance at €2.5bn with no senior issuance worth mentioning, although several European banks have issued AT1 debt in US dollars. The corporate issuance levels have surprised us, and the month has been quite good from the perspective, although most of the supply came in the opening two weeks of it. We could reasonably expect issuance to be at high levels – an even start today as borrowers seek to gain advantage of printing early so as not to be lost in a daily flurry – should it come through September.

Total issuance YTD is now up at €177bn 1. We have had several decent months since the poor issuance levels in January and February. With effectively 3 months to go before we hit the usual December lull, we can expect Sept-Nov to offer perhaps €80bn of non-financial supply, which would take us to around the €270bn area for the full-year and just shy of the annual record set in 2009 of €290bn.

Other than that, we have non-farm payrolls on Friday (forecasts: 185k consensus on payroll and unemployment rate to drop to 4.8%) amid a slew of economic data. There are various Fed speakers who will be watched for clues as to what the next FOMC might bring. It’s also month-end week, but it might not necessarily be a quiet end to it in the credit markets if corporate issuance kicks off right away.

That’s it, have a good day. Back tomorrow.

Notes:

  1. Source: Dealogic

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.