11th January 2016

On the ropes

MARKET CLOSE:
FTSE 100
5,912, -42
DAX
9,849, -131
S&P 500
1,922, -21
iTraxx Main
86bp, +5bp
iTraxx X-Over Index
353bp, 10bp
10 Yr Bund
0.51%
iBoxx Corp IG
B+160bp, +0.5bp 
iBoxx Corp HY Index
B+543bp, -1bp
10 Yr US T-Bond
2.12%

Reasons to be fearful… The markets failed to gain any traction after China’s decision to do away with those stock market circuit breakers. The very small bounce in Chinese stocks at the end of last week was, we believe, more attributable to some weekend short covering trades than to relief. Elsewhere everything reacted with a whimper and seemed unimpressed. Basically, we are all still nervous, and unfortunately it’s getting to the stage where we should probably fear the worst. The non-farms payroll report was solid as could be, and US rate hikes are coming, but we can only hope they are extremely measured and the Fed-wallahs are aware of the risks higher US rates pose given the renewed fragility in the global economy and financial markets (that includes in the US itself). It should not be lost on anyone how important Chinese growth is for the whole gamut of global markets. After years of consuming with gluttonous intent, a painful multi-year internal restructuring is occurring. And there is going to be no “get out of jail free” card – that will stay with the famous board game. The adjustment process is going to be painful and the volatility we have seen in this past – difficult – week might be just a harbinger of things to come. European exports (and others) will likely suffer, and this will be apparent in the data in the next few months. Look for oil to drop some more, base metals and other commodities to fall, investment to slow further and global growth to miss already lower targets (OECD predicts 3.3% for 2016). That means equities still appear overvalued and government bond yields look anchored or set to go lower from here. Credit will whipsaw depending on how equities move, while further pain in US HY will possibly have more than just a transitory impact on the HY market in Europe.

And some to be more cheerful… There is hope that further stimulus from the Chinese can contain the current weakness in its economy and help improve sentiment such that stocks stabilise and the global financial markets feed into this. That any emerging weakness in eurozone industry on the back of the more recent Chinese worries is therefore short-lived. After all, Spain appears to be on a decent recovery trajectory, and this could be sustainable. Eurozone unemployment has been falling of late and could be into single-digit territory come mid-year. As for the ECB, the ongoing weakness in oil prices will have prolonged deflationary affects: it will most likely be forced to announce additional (and finally actionable) measures in the next 2-3 meetings. That could help to improve sentiment. The Fed might well offer a stance more conducive to slower rate rises, as per Governor Yellen’s previous musings. The US economy is going great guns as judged by the stellar non-farms report on Friday; this might continue for a good while yet, acting as a welcome offset to any further weakness elsewhere around the globe. Fingers crossed, we chug along – not too hot, not too cold, rates stay supportive, equities find a floor, earnings hold steady albeit at lower levels and sentiment keeps risk assets at these levels or a little better.

Where do we stand? Unfortunately, with the former.

Market volatility set to continue… There was hope at the open on Friday that the Chinese had finally cracked it regarding the circuit breaker brouhaha. No such luck. Back to the drawing board for them, and a new design needed for the circuitry. Nonetheless, we tried to rally, but faded it in double quick time. Later, the payrolls data gave hope that the US (consumer) would save the world from a major downturn. We rallied, then faded it again, perhaps on the realisation that the Fed would ratchet rates higher, quickly. In between, oil caught a bid, excited that Aramco was going to be IPO’d. We faded that too, and oil prices fell into the close. The DAX is the bellwether for Europe in almost every sense, as a measure of its economic wellbeing. It is down almost 900 points in the opening week of the year – around 8.5%. The S&P is off 6% in the same period. Government bond yields resumed their decline, with the 10-year Bund back at 0.51% and the 2-year at its record low of -0.40%. Those moves pretty much sum up a difficult session and week. In credit, we edged a tad wider in cash, which left the Markit iBoxx IG corporate wider at B+160bp, but the index yield fell more and returns improved a little (still a small negative in the week). The HY market closed a touch better, at B+543bp (-1bp), suggesting overall that the credit market is holding up well. That said, if one can’t trade, and there is limited flow and volume, we can’t really feel where the market is. Primary was quiet all week save for a whole host of covered bond deals. The iTraxx indices closed much better bid (higher) and at around contract highs with Main up at 86bp and X-Over at 353bp. The synthetic indices will continue to dance to the tune of the equity markets and represent the cash corporate markets own barometer for sentiment. On the primary front, we had just one deal in the opening week of the year, with non-financial corporate issuance totalling Eur3.25bn off a three-tranche deal from Daimler.

Next up?… US stocks closed 1% lower and so have likely set the tone for Monday’s opening: weaker. Over the weekend, Chinese consumer prices for December were published and they rose by 1.6% (as expected), but producer prices fell by 5.9% again. Industry will have to cut its cloth accordingly, so to say. At time of writing the Asian markets have not opened, but we think they will probably offer little reason to be cheerful when they do. Away from that, we have the US earnings season to look forward to, and how ironic that base metal industrial giant Alcoa traditionally gets us started (after the close tonight), with the likes of Intel and JPMorgan to follow later in the week.

Keep everything crossed. Here’s to a better week.

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.