- by Suki Mann
iTraxx X-Over Index
10 Yr Bund
iBoxx Corp IG
iBoxx Corp HY Index
10 Yr US T-Bond
Let the battle commence
That’s a late Easter out of the way, and on to the next significant road bump to manoeuvre – but which then leaves us with a clear run for a few months; The French elections.
The markets are poised and perhaps positioned for a potential upset. The 10-year Bund is yielding 0.19% and that’s not solely down to escalating Middle East tensions. The worst case for the markets would be a second round play-off between the far left (Melanchon) and the far right (Le Pen). Anything else likely results in a Macron victory, relief for the markets (rally, that is) and just the Trump/Russia/Syria situation to sully performance as we head to September’s German elections.
Next Sunday’s first round of the French election is going to be close, and we think potentially to write this week off in terms of major activity.
So, equities will gyrate to the macro and geopolitical news flow and the earnings season, while government bonds will stay better bid whatever happens over the next few days. Corporate primary ought to be light (just has it has been all month) and spreads will move in a small range but edge wider, we would think.
A little bit of this, and a bit of that
The credit market closed out a touch wider for choice into the final session before the long Easter weekend, with the index (Markit iBoxx) at B+132bp. At that level, the index is a paltry 2.5bp tighter versus where it stood at the beginning of the year, while the ECB’s average weekly long-term bond grab of €1.8bn hasn’t had an impact on the market. Yet, when the central bank’s QE operation began, we were looking at the potential for spreads to ratchet tighter to record levels.
The worry for some might be that if the ECB’s near €80bn of purchases (13%+) of the eligible IG non-financial corporate debt market can’t see us materially tighter, then any reduction in purchases might see spreads go wider. The week before last, into the overall reduced bond buying programme (€80bn to €60bn per month), corporate bond purchases actually increased to around €2.4bn. And spreads have edged wider. Anyway, returns for IG credit are up at 0.9% YTD, owing to the rally in the underlying. We note also, that there has been no appreciable or noticeable pick up in issuance as a result of the ECB’s QE effort.
It is a similar picture in the sterling market. At the end of last week, the BoE announced that it had bought £9.6bn of investment grade debt (and almost £500m in the week). The bank is now just £400m shy of its £10bn target which was supposed to take 18 months to complete – and not the 7 months it has taken!
Still, spreads in this market are a basis point wider this year, and 3bp wider since the bond buying operation began! Mind, returns this year are up at a stunning 2.5%. Alas, most of that is simply because Gilts have rallied this year and that’s good news for this longer duration corporate bond market.
There has been a retrenchment in spreads in the high yield market of late, we’re around 17bp off the tights we have seen this year, as measured by the iBoxx index (B+380bp), but still the index is 33bp lower YTD. Returns are flying, giving us 1.9% YTD. We’re not concerned at all at the retracement in spreads in this market, the 33bp of tightening already being a very good effort. If macro is returning to some sort of sustainability in growth, then improving credit metrics and still good demand for higher yielding risk assets will leave this market to perform very well this year. The receptivity to new deals has also been excellent, and levels of issuance encouraging.
Primary loses its sparkle
After a super March and an excellent opening quarter which saw issuances of IG of €37bn and €88bn, respectively, April has been a major disappointment so far. We’re past the half way stage of the month and much potential event-risk lurks over the next couple of weeks. Can this month see €20bn printed against the €5.3bn offered so far? We think it is a tough ask for that to occur given that a couple of session either side of this weekend’s French election might curtail any meaningful activity.
The high yield market has similarly been delivering more than we might have anticipated in primary and there is still a significant pipeline of deals. After €16.3bn of issuance in Q1, with €10.3bn of that in a super March month, this month has piped up with €2.6bn to add to that total. Achieving €5bn for the month would be a fine effort for this market.
The week ahead
Almost 15% of the S&P500 grouped companies report this week, so a keen eye will be cast over their performance as an indicator as to how things are evolving for the corporate sector in the US (Bank of America, Johnson & Johnson and Goldman Sachs are amongst those due this week). Data will focus on the US industrial sector. In Europe, everything will be secondary to next Sunday’s French election first round. The US stock markets closed with strong gains (+0.9%), so today’s session in Europe might reflect a risk-on stance.
Still, our expectations for government bonds is that they will reflect a defensive posture by investors – that is, better bid. If anything, they will possibly head a little lower, having broken out of their recently medium-term established ranges. We also think that the Bund-OAT spread might head into the 80s (74bp currently).
And for corporate bond spreads, we would think that if the market does have a more defensive feel about it (this likely will be the case), then spreads are only going a little wider into it. And that is even after all that demand from the ECB’s QE purchase programme, positive and improving credit fundamentals and still very supportive corporate bond market technicals.
Have a good day.
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