25th April 2017

Risk on – markets react to French election result

FTSE 100
7,265, +150
12,455, +406
S&P 500
2,374, +25
iTraxx Main
68bp, -6bp
iTraxx X-Over Index
272.5bp, -18bp
10 Yr Bund
0.33%, +8bp
iBoxx Corp IG
B+126bp, -5bp 
iBoxx Corp HY Index
B+354bp, -18bp
10 Yr US T-Bond
2.27%, +3bp

Calling a spade a spade

The polls finally got it right – our faith in them has been restored! And there was relief all round, especially for anything with a French flavour to it. The CAC jumped by almost 5%, OATs recovered 10bp in the 10-year maturity and French corporate spreads outperformed. Bunds underperformed as safe-haven risk was shunned.

So, that’s a good starting point from which to work from. We think the market will now trade at around these new levels anticipating a Macron win and then thinking about how the world looks after the French parliamentary elections of which the potential make-up threatens to leave Macron as a lame-duck President. It’s as if Hollande never left.

If so, the medium-term means that nothing really changes in France although the EU will no doubt see it as vote of confidence and rejoice that it lives on to fight another day. Then we can all move on to June 8 and the UK general election. Prime Minister May will likely return with a bigger majority than she already has and the Brexit negotiations can begin in earnest.

That’s the politics out of the way, in a nutshell. The markets can now focus on the earnings season (which has been delivering its usual level of beats/misses), on macro which suggests we’re heading into some sort of sustainable uptick in growth, and positioning ahead of the summer break – albeit giving us a couple of months of activity in which to fill our coffers.

We would think a small up/down from here in equities once the French election result euphoria fades and rate markets should see the 10-year benchmark Bund level play out in its now medium-term range 0.20 – 0.50%.

Credit spreads ought to inch tighter amid poor secondary market liquidity, reduced interest by investors to get involved and an uncertain primary market. They ratcheted better yesterday!!! Hopefully, the best of the excitement isn’t confined to Monday’s moves. The primary market has overly disappointed this month, though, and we can only hope for a pick-up from now on – earnings season blackouts or not – given that the pipeline is rammed. But borrowers continue to bide their time, fearing a dud deal or rejection – no matter how unlikely this is going to be.

Relief everywhere the order of the day

LeasePlan: €500m in a long 3-year primary deal

The closing out of market shorts made for reactions which were extreme to say the least. The CAC being up by well over 4% was one of them, but the iTraxx index rallying 20bp at one stage in X-Over was another. We dare doubt it will be heading higher, though, as the market shorts (index longs) are closed out and we reassess the value of the risk in the corporate bond market with greater level-headedness.

Anyway, US stocks pushed 1% higher which helped to sustain valuations in Europe and the DAX saw a new record high (+3.4%/+406 points in the session). US Treasury yields backed-up to with the 10-year at 2.27% (+3bp).

So the markets held on to those early gains which left the 10-year OAT to yield 0.77% (-10bp), the equivalent maturity Bund to yield 0.33% (+8bp) and the differential between them drop to 44bp at levels not since last year. We would think it probably settles here for now with perhaps a break to the 50bp level into any pre-second round volatility, but with a renewed push lower once it is confirmed (some complacency from us here) that Macron is the new occupant of the Elysee Palace.

The primary credit market was quiet again, but not a complete blank. There was nothing from the non-financial sector, but we did see LeasePlan take €500m in a long 3-year deal off a €1.25bn book. Morgan Stanley lifted €3.5bn in a dual tranche offering following on from a big deal seen last week from BofA. That’s five straight sessions now that have failed to elicit a single non-financial corporate bond deal. Since the beginning of last week, we have had just two high yield borrowers in the market (for a combined €650m).

ECB QE corporate bond holdings pass €80bn

The latest ECB investment grade, non-financial corporate bond purchases came in at €1,482m and was a drop of €210m versus the prior week – and the long-term weekly average accumulation of corporate bonds is now €1,762m. However, the last couple weeks have seen lower than the long-term average of weekly accumulations, and might now represent a lower level of purchases from the bank given the reduction join overall bond purchases from €80bn to €60bn per month. Still, even at that level – or less – and we did have the long Easter weekend to contend with, corporate spreads should be ratcheting tighter.

Recent ECB weekly purchases

The total purchases to date, after 46 weeks, stand at €81,044m – and this is debt that will be held by the central bank until it matures (over 13% of the eligible market).

Credit spreads finally ratchet tighter!

As we suggested in our previous daily, any major move higher in equities will have a direct impact on valuations in higher beta credit markets – namely, the high yield market. But we wouldn’t expect the broader market to necessarily push aggressively tighter. It did yesterday, but we wouldn’t expect much of a follow through in the next few sessions. For the synthetic indices, that positive tone is reflected through the iTraxx indices, and X-Over eventually closed 18bp lower at 272.5bp, with Main tighter by an impressive 6bp at 68bp.

In the cash market, investment grade risk was easily much better bid and the Street took the opportunity to tighten up the market amid reduced offered side liquidity. Still, we saw one of the biggest cash index moves ever with the Markit iBoxx index 5bp lower at B+126bp – and the lowest level seen this year.

Higher beta was where the action was and we squeezed hard with the CoCo index tightened by 40bp alone! These were the lowest levels since July 2015. Corporate hybrids also squeezed aggressively, with the index down 20bp in the session and back at mid-2015 levels. The sterling market was a little underwhelmed by it all, the index a couple of basis points lower at G+151bp.

And finally, the best ’til last. The high yield market rallied very hard, and spreads tightened by a stunning 18bp as measured by the Markit iBoxx index. This was a completely risk-on session and highlighted the lack of supply, the lack of inventory and investor/Street confidence in the set class. At B+354bp, the cash index level is the best recorded this year so far (and lower than our y/e forecast already) – and the tightest level seen since the middle of 2014! High yield bond market returns are up at 2.3% year to date, but many will have exceeded those index return levels given the orientation of their beta.

Have a good day.

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

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.