6th April 2016

A sense of déjà vu

MARKET CLOSE:
FTSE 100
6,091, +-73
DAX
9,563, -259
S&P 500
2,045, -21
iTraxx Main
77bp, +4bp
iTraxx X-Over Index
318bp, +14bp
10 Yr Bund
0.10%, -3bp
iBoxx Corp IG
B+149bp, -0.5bp 
iBoxx Corp HY Index
B+529bp, +3bp
10 Yr US T-Bond
1.72%, -4bp

What’s it telling us?…

That is, the 10-year Bund yield at 10bp and the lowest closing level in 12-months, now left just 5bp off its record low. It tells us that the ECB is manipulating the market with its now increased €80bn monthly asset purchase grab. But also, that they must have known the eurozone’s economy was heading lower before they kitchen-sinked it at the last meeting. Judging by the data flow, there doesn’t even seem to be the sense of stability in sight.

Negative yielding: German government bonds

Yesterday, we saw German factory orders at a six-month low with a 1.2% fall in February, the Nikkei fell 2.4% amid broad Asia weakness and eurozone service sector activity for March decline sharply. The net effect is that global economic jitters remain, with little sign of a pick up in inflation (OECD inflation slowed), consumption growth or sustained industrial activity. The IMF waded in with their words of wisdom too. The safest of all European assets, German government bonds, are now negative yielding all the way out to 9-years, which means you pay to hold them.

It will soon be that the 10-year heads that way. Don’t worry about the timing or a pull back as we saw a year ago – just position for it. All the while, the euro is stubbornly strong against the dollar as oil starts to head lower, heaping more angst on the ECB.

There’s no quick fix, no easy way out. Structural reform is absent as the politicians are occupied elsewhere (Brexit, terrorism, geopolitics, their own jobs) and so we ready ourselves for the long, hard slog ahead. Get used to low returns, low yields, tightening spreads, more speculative bubbles and dare we suggest, another round of easing – of some sort, in the second half of 2016.

No point in adding core government bonds, or stocks. The former offers very little and the latter promises a hit on capital. Peripheral government bond risk will benefit from investors dispersing into higher yielding government bonds, while the corporate bond market will possibly be that pot of gold at the end of the rainbow. 4% returns in IG are going to happen if the central bank succeeds in dumbing “it all down to zero”. We’re already at +2.6% YTD in total returns, and spreads are not likely going wider while underlying yields will be going lower. We can worry about 2017’s performance and potential opportunities in late Q4.

Manipulation and fear

The demand for corporate bonds is now at insatiably high levels. There’s no secondary repricing impact from the wide IPTs while performance of new issues will breathe confidence into the market as a whole. Almost like a broken record, we’re going tighter. alstriaRelatively unknown German REIT Alstria Office managed book close on €3.5bn for a €500m, 7-year deal with pricing 25-30bp tighter than initial guidance at midswaps+205bp. This deal was delayed from early February as investor feedback suggested a deal would work in the higher 200s! Now that’s the power of the ECB’s upcoming bond grab – and a case of “Thank you, Mr Draghi.”

Admittedly, the group’s 21s were at midswaps+250bp area back then versus +180bp now. The group is also in the market with a 3-tranche Schuldshein deal. France’s electricity transmission system operator RTE raised €1.35bn in longer-dated funding (10.5 and 20 years) and combined books of €9bn allowed the leads to tighten up the deals by 20bp. There’s a pattern emerging here! Finally, CK Hutchison came up on the rails to lift €2bn in a dual-tranche transaction.

The month – just 3-sessions old – and we have already had €8.1bn of non-financial issuance. €27bn is the record for an April which was raised last year, and we think that this market could easily absorb €40bn without an adverse impact on performance. That level is not impossible given that we have a full month ahead of us (Easter came early). BNP was the sole senior debt borrower for €650m in a long 6-year.

Mid-February blues all over again…

For everything except corporate bonds and safe-haven government bonds! Stocks plummeted, oil prices dropped and government bonds were bid up as the market went risk off and fled a little to safety, while few dared to tweak corporate bond exposure lower. Even Gilts joined the party with the 10-year dropping 5bp in yield (strong auction, it was 8bp lower at one stage) which will only serve to improve returns for sterling corporate bondholders too. No Brexit fears impacting this asset class.

Sterling corporate bond spreads were unchanged while returns edged up, to 2.9% YTD. Peripheral government bonds underperformed and yields backed up by between 4-20bp for Italy, Spain and Portugal. The DAX closed 2.6% down with other bourses 2% or more lower, as a sea of red marked equity valuations. Oil bounced into the close but prices seem to be heading down with WTI trading off a $36 per barrel handle and Brent $38, for the moment.

For corporate bonds, spreads edged better, leaving the broad Markit iBoxx index at B+149bp and the index yield at 1.31%. That’s a very good day at the office given that equities were pummelled. Higher beta was only a tad weaker amid low flows and volumes, with moderate weakness in CoCos and hybrids while the HY index moved up 3bp at B+529bp. Credit market sentiment and market direction risk proxies – the iTraxx indices, was where we saw weakness. Main was up 4bp to 77bp and X-Over closed 14bp higher at 318bp. A pointer for how we might start today comes from the US close overnight; Stocks dropped by 1%.

Have a good day.

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.