- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
|FTSE 100 ,||DAX ,||S&P 500 ,|
Playing the cycle…
So who thinks credit looks too rich? Spreads are at historic tights in IG, are pretty much there in high yield and the new ‘super’ subordinated contingent convertible market has valuations also at record tights – even if that market is only 3 years old, and borne out of the financial crisis.
As far as IG is concerned, we’re just inside levels pre-crisis (2008). Back then the economy was nearing the end of its cycle (as we now are aware – in hindsight), there was some serious manipulation of the market through the excess leverage in the system driven by the boom in structured products and we’d apparently seen an end to boom and bust. Now? The economy is also on the up, rates are close enough to record lows – funding costs certainly are, the world is flush with liquidity, we have our own market manipulation through central bank largess, while the ability for the corporate sector to service its obligations is the best it has ever been.
In that sense, we think current valuations are completely justified. After all, in IG we through the levels seen back when the last crisis began in 2008. The outlook seems to be brightening as all the major economic powers USA, Eurozone, China and Japan seem to be growing in unison. For corporates, better macro underpins and usually sees an improvement in credit fundamentals although some of that is tempered by releveraging which might come from higher investment and/or greater debt financed M&A activity.
Overall, though, an improving global economy will see a tighter spread environment. We probably don’t look rich versus equities, but equities have multi-asset investors excited because the potential capital growth far outweighs income.
That said, we don’t see any hurry anywhere to switch. Government bonds might be having a more difficult time of it this year (returns are going to be negative) as they adjust to central bank policy, growth and potentially higher inflation levels. Credit market participants with total return objectives have likely already battened down the hatches expecting more meagre returns versus last year.
Benchmarked investors will be feeling much happier as IG grinds out performance while they run portfolio betas in excess of the index in order to gain incremental upside. Hence the strong performance of the contingent convertible market. We’re going to squeeze more out of this product. It’s no coincidence that the (more liquid) RBI deal launched on Wednesday is already up 2 points.
Looking at the compression between senior and subordinated bank debt. In the pre-crisis era, that differential was around 40-50bp in the senior-subordinated spread (iBoxx index) where the latter was predominately LT2 debt. Now that iBoxx index spread 70bp and declining. It was closer to 30bp for the debt of some individual borrowers. The senior-CoCo spread difference has declined from over 800bp a year ago to 235bp now, and as we suggested in Wednesday’s comment, is on course for a level around the 150bp area. Keep adding that CoCo risk.
Busy primary for some
Primary was busy again but the deals were SSA oriented and in dollars and sterling, mainly. The corporate sector had a quieter time of it. IG non-financials drew another blank after Wednesday’ zero session, and we are stuck at €15.5bn for the month’s issuance so far. We would think that €30bn as a target by month end is looking unlikely now. We were up at €27bn in January 2016, but given December’s low level of issuance which barely saw €7bn, we might have reasonably expected a more effusive month now. It’s not happening for the IG non-financial sector at the moment.
There was nothing from senior financials either, although Leasplan lifted €500m in a 3-year floater at midswaps+32bp, off a 4x subscribed book which allowed the borrower to reduce the final pricing by around 8bp. In the high yield market, there was nothing in the euro-denominated area, but sterling was again delivering deals, this time as Matalan came with a dual tranche offering. The £350m 5NC2 and £130m 6NC3 deals generated order books of £1.2bn combined offering yields of 6.75% and 9.5%, respectively. On Friday, we likely have Selecta pricing up a 4-tranche multi-currency SEK/CHF/€ offering and possibly Lowell group with a dual tranche offering.
We wrapped up with nothing less than a sovereign deal from Austria as it took €4bn, taking us well past the €30bn mark for sovereign issuance so far this year.
IG credit – new record levels
Rate markets took another pounding with the 10-year US Treasury yielding touching 2.62% in the session and closing at 2.61% (+3bp) with the likes of the Bund yield edging higher too, left at 0.57% (+1bp). There was weakness in most safe-haven rate markets although there was better bid for higher yielding peripheral paper.
Eurozone stocks were generally a small up, with the DAX doing much better as it rose by 0.8%. Trading businesses for US banks generally had a tough time of it in the final quarter, but overall, other business were quite strong and Wall Street banks again delivered decent earnings for the fourth quarter as Morgan Stanley and Goldman’s reported. And Bitcoin rebounded hard, up between 15-22% in the session. US stocks played out the session a very small down/mixed taking a breather again following the very strong session previously.
In the synthetic credit space, iTraxx Main edged lower to 43.5bp (-0.7bp) but X-over didn’t follow the same direction as it moved higher to 34.5bp (+2bp).
The IG cash market was better bid and we squeezed some more to B+88.7bp which took us to a new record low for the Market iBoxx index. The CoCo index also tightened to B+309bp (-5.5bp) to a fresh record low too. The index yield dropped to less than 3% for the first time, to 2.98%. It’s eye watering.
Given the trend we have seen this year, the high yield corporate market is less in focus but prices did edge higher leaving the index at B+273.2bp (-1.3bp).
Have a good day.
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