- by Suki Mann
|iTraxx X-Over Index
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY Index
|10 Yr US T-Bond
We have a story developing. The bond markets are telling us that the start of the great recovery is upon us. Spanish unemployment fell below 20% for the first time in 6-years, UK GDP defied the negativity engulfing the mood of some post-Brexit as it beat expectations in Q3 with growth of 0.5% although the results season continued in mixed fashion. 10-year Bund yields rose as much as 8.5bp to 0.17%, 10-year Gilts saw 1.25% (a massive 10bp higher), BTPs were back above 1.50% (!) and the US equivalent maturity was siding up to 1.85%. Oops indeed.
Admittedly some of the recent economic data has been a little better rather than a little worse, and that is how all recoveries start. We’ve previously suggested that the 10-year Bund yield would see -0.20% before +0.20% and having got to -0.16% intraday a couple of weeks ago, it looks like we are way out of the money on that trade now.
So, do we have the onset of some sort of recovery to justify the rising yield environment? We don’t think so. But the ECB has been doing much heavy lifting of government and corporate debt that the former continues to defy the manipulation – and the market is working to suggest that recovery is nigh. If so, we’re going to see returns dwindle for fixed income investors having help up so well for most of 2016.
It means, ultimately that equities are going to be in vogue if investment and capital expenditure and earnings eventually start to perk-up. It is going to see, as some stage, the rotation trade away from low yielding but hitherto capital preserving corporate bonds (especially) into capital appreciative assets – namely equities. And it could all look ugly.
Alas, don’t fret, yet. Let’s not get carried away around where the government bond yield is heading. After all, were talking in the context of 10-year Bund yield barely above 0% and the 2-year at -0.64%. The ECB has deposit rates at -0.4% and the BoE at 0.25%. Recovery anywhere is anything but assured. We have become accustomed to extrapolating moves away from these extremely low levels too hastily.
We would say that Doomsday for corporate credit is a long way off. We still think that government bond yields stay relatively low (like they are) or go lower again in due course. And these current moves might be the result of a tetchy investor base having had such a good year (returns wise) that nerves are getting the better of them.
Corporate bond markets still printing
Demand for corporate bonds is as resolute as at any stage of this year. No nerves here. This year’s near €245bn of non-financial IG issuance will see us out as the second best on record, likely. We had another couple of borrowers enter the fray yesterday, but the volume did drop off quite markedly versus that of Tuesday (€6.2bn, from one borrower) and Wednesday (€5bn from three borrowers). Publicis clipped €500m in 7-year funding and PPG Industries took €900m in a dual tranche transaction giving us €1.4bn for the IG non-financial market. TVO and Whirlpool are likely due today. The week’s volume before the two aforementioned possible deals stands at €12.6bn and just than doubles the monthly level to €25bn.
In high yield, we had BUT SAS in for €380m (still to be priced at time of writing), while SIXT (we think X-Over implied rating at best) issued €250m in what became an interesting session for this market. That’s because Austrian automotive parts supplier Benteler International pulled its anticipated 6-year deal late into the afternoon. We also have Wind Hellas (€250m) due as well as Owens-Illinois (potential €600m).
And spreads holding their own
The BoE announced that the first month of corporate bond market QE operations had seem them relieve the market of £2bn of debt. They aim to buy £10bn over 18 months and it would appear that this amount of buying means that investors have not been backward in coming forward to hit the Bank in the reverse auction process.
It’s also quite clear that the Bank’s involvement is the chief reason sterling corporate spreads have remained well-anchored in the face of some serious pressure of late on Gilts and, since Brexit, on the currency. In the session, we had spreads edge better for choice amid little real activity, but returns YTD have dropped to “just” 10.3% as measured on an index basis. Admittedly, sterling corporate bond returns were up at 17%+ a few months ago.
Elsewhere, it was a similar story with euro-denominated IG corporate secondary credit markets in decent shape. We continued to grind better. The scarcity of secondary debt and turnover – and the ECB, are helping spreads tighten. We had another session where the Markit iBoxx index edged tighter leaving the index down at B+120.8bp (-0.5bp) and ensuring that spreads have tightened every session this month. The index yield came under pressure (up at 1.04%) and returns took a beating. Unfazed, the high yield market was also better bid – again, and cash index spreads saw another squeeze better.
We closed out with stocks close to unchanged, government bonds selling off in one of the worst sessions for a while for them, and corporate credit holding relatively firm into it albeit with returns under some serious pressure. At this rate, we might just want the year to end!
Have a good weekend. Back on Monday.