4th January 2018

Credit’s glorious decade

MARKET CLOSE:
iTraxx Main

43.5bp, -0.8bp

iTraxx X-Over

223.9bp, -4.8bp

10 Yr Bund

0.44%, unchanged

iBoxx Corp IG

B+93.5bp, -1.1bp

iBoxx Corp HY

B+276bp, -6bp

10 Yr US T-Bond

2.47%, +2bp

FTSE 100 , DAX , S&P 500 ,

The financial crisis has been kind…

It didn’t take long at all, into the new year, for the IG cash corporate bond market to hit new record tights (Markit iBoxx IG cash index at B+93.5bp), capping off a remarkable journey for the corporate bond market since this crisis began. Year after year – almost – we have had positive performance (in returns and spread tightening). The default rate having peaked at 14% and well below expectations of over 20% in 2009, and has easily held below 3% ever since and sustained confidence. The market has been easy to trade. It has been a strange cycle, though. A stretched-out one. Central bank policy aimed at heading off a global financial crisis which saw them flood the global markets with liquidity created a 10-year boom period for corporate bond investors. If one got it wrong, it is because they didn’t take on enough risk.

It has been a beta game all along – the higher, the better. The banking sector was/is bailed out and new, expensive obligations for banks to issue have been created to improve capital buffers. They’ve carried the full weight of the regulatory backlash and burden (rightly so). The CoCo bond market has had a great 2 years out of it with investors clipping massive returns.

The high yield market is no longer described as a fledgling one. For so many years, hamstrung by the poorest of liquidity and low levels of issuance, last year we saw a record €75bn issued which was €18bn more than the previous record). We returned 6.3% or more and spreads are again heading to record tights. The ECB has played a dramatic and manipulative hand in it all, buying €130bn of IG non-financial debt over the past 18 months which has forced investors into the asset class. It’s been a good trade nevertheless, and few will quibble.

We’ve been through a few hairy moments, too. The Scottish and Brexit referenda, the latest US elections, ongoing geopolitical concerns in the Middle East and tensions escalating between the US and North Korea. We’ve seen out a slump in the oil price, a savage defaulting in the US oil shale gas producer sector and the Greek crisis. In credit, a noticeable development has been around secondary market liquidity and the ability to trade at a reasonable price at the best of times, in size, which has been lost as we morph into a kind of buy-and-hold market.

But we are still standing. The global economy might not have been firing on all cylinders for the past decade, but has shown enough to sustain corporate profitability at levels enough to see record stock market levels in many cases. While the low interest rate regime has made sure that the ability and willingness of corporates to service and finance/refinance their debt obligations as they come due is undimmed.

Investors have played their part. They have recognised the attractiveness of corporate debt either as a diversification play or a more stable, worthy longer term investment offering a high level of security and a decent coupon to clip. The corporate bond market has grown exponentially as a result of it all, way over €2trn in outstanding debt versus less than €1trn just 10-year ago. We’ve got another year of it to go, before we potentially have a re-think.


Financials dominate primary

Senior issuance appeared for the first time this year as UBS and BNPP printed along with a cacophony of covered bond issues. UBS issued a combined €3bn of OpCo debt in 2-year floater and 4-year fixed formats, while BNPP took €1.25bn in senior non-preferred issuance for a June 2026 maturity. UBS also issued £1bn of OpCo debt in a 2-year maturity at Gilts+73bp.

The covered bonds came from the likes of Westpac Banking (dual tranche), Santander, CA Cariparma and Stadshypotek, while Slovenia was the sovereign offering of the day.

In non-financial corporates, the auto theme continued as being the only driver for issuance in town, with Daimler opting for 5-year floating funds at midswaps+25bp for €750m – the deal coming after RCI and BMW in the previous session. We’re just waiting for the high yield market to open its account, likely next week now given the longer lead times needed to get a deal on the screens and printed.


Macro upbeat some more

The day’s flow of data and economic news was again positive, starting with Spanish service PMIs for December at 54.6 and up from 54.4 recorded the previous month, illustrating that the improvements in the economy continued despite Catalonia concerns. For the Eurozone as a whole, the services PMI was equally ebullient while the composite PMI rose to a 7-year high of 58.1. Later, and it augers well for the non-farm release on Friday, the US ADP private sector employment report had a strong showing (250k jobs added versus 19ok expectations).

The oil price closed in on $68 as Iranian tensions persisted, but also on hopes that the global economy remains on a solid footing adding to ongoing demand (US crude stockpiles fell by much more than expected in the week to end December).


Records galore

All three US equity indices continued to set intra-day record highs as did the FTSE. The DAX rose by almost 1.5%. The S&P shot through 2,700 for the first time a couple of days ago, the Dow raced past 25,000 for the first time on Thursday. That’s a thousand points added in a month for the Dow! There’s no stopping stocks at the moment. Only crypto is having a more difficult time of it at the moment with the benchmark Bitcoin languishing on fears of greater regulation on the horizon for the crypto world.

The US tax reforms and stronger economic growth expectations are being embraced by the markets. Rate markets are beginning to feel a bit leggy on the back of them. The US 10-year yield rose to 2.48% (4bp). In Europe, the Bund yield in the 10-year was close on unchanged at 0.44% while the Gilt yield rose a touch to 1.23% (+1bp) as it continues its new year rollercoaster rise.

As we might expect, and in line with sharply higher stocks, the better tone overall fell into the hands of the iTraxx indices and the cost of credit protection duly declined. iTraxx Main was 0.8bp lower at 43.5bp and X-Over was 4.8bp lower at 223.9bp. By way of a reminder, we are targeting a year-end level of 35bp for Main and 180bp for X-Over.

In the cash market, we were only ever going to go tighter in line with the broad risk on tone. Risk assets are in rally mode and we saw the IG market reach new record tights of B+93.5bp (iBoxx index). Our year-end target of B+85bp already looks far too conservative given we have moved 2.5bp since we reopened for business.

In the higher yielding sectors, the squeeze is on. The CoCo iBoxx cash index marched tighter and to a new record low of B+346bp (-14bp) and is 17bp tighter in the opening three sessions of the year. This is a fantastic effort and highlights that confidence it the Street as well investors to still plug away at adding higher beta assets. For the high yield index, amid little activity and poorer liquidity, we tightened by 6bp to B+276bp which is 10bp tighter this week so far.

Friday will be a very limited session given the release of the December non-farm report, where consensus expectations are for 190,ooo additions and unchanged unemployment rate of 4.1%.

Have a good day.


For the latest on corporate bonds from financial news sources, click here.

Suki Mann

A 30+ 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 CreditMarketDaily.com.