29th October 2017

Show me the money

MARKET CLOSE:
iTraxx Main

51.4bp, -1.4bp

iTraxx X-Over

232.6bp, -4.5bp

10 Yr Bund

0.39%, -4bp

iBoxx Corp IG

B+100.7bp, -1bp

iBoxx Corp HY

B+264.5bp, +1bp

10 Yr US T-Bond

2.42%, -4bp

FTSE 100

7,411.34, +21.88
DAX

13,167.54, +108.88
S&P 500

2,599.03, +16.89

Powering on…

There are just two sessions to go before we close out a super October for the higher-yielding end of the corporate bond market. The Markit iBoxx HY cash index has tightened by 18bp, the CoCo index by 49bp and even the non-financial hybrid index (already extremely rich) is 24bp tighter in the month so far. They’re all at record tight levels for the respective indices.

The better economic backdrop is the driver as it has helped sustain equities at – or even pushed them to setting – record levels. That confidence has filtered through to other risk assets and especially ones more closely correlated with equities. And all that even as the tightening cycle is underway, but because it is so much in its infancy, the credit markets will continue to trade as the ‘go to’ product for yield hungry investors. Monthly and year-to-date excellent total return performance will only serve to suck in more funds to an asset class where, in 2018, ought in no way deliver the kind of performance it has in a stunning 2017.

Equities were the story last week. The melt-up in US equities was incredible following a raft of positive news on Friday from Apple which took in Amazon and Microsoft and smashed indices to new record highs. It wasn’t all positive because we had consumer retail related company profits record misses versus expectations (Colgate-Palmolive, JC Penney), but Apple’s latest iPhone sales were “off the charts”, while overall the quarter’s US GDP came in at a much better than expected 3% (estimates 2.5%).

That GDP news augers well for this week’s October non-farm payroll release which also means it is good news for equity markets which maintained a clear, significant bullish tone in last week’s final session, especially in the US. All that after a perceived dovish ECB meeting last week. Fuel for the fire. We saw intraday record highs on the DAX, almost decade old highs on the CAC, with the S&P and Nasdaq powering ahead to fresh records.

Fixed income found some support with a bid for Eurozone government debt on the back of that reduced ECB QE purchases news on Thursday which was still being greeted positively. The sour news came from Catalonia’s formal declaration of independence and the Madrid government’s intervention as it took direct control of the ‘rogue’ state, which had Spanish Bonos under some pressure and the 10-year yield rose 5bp to 1.60%, before closing at 1.58% (+3bp).

Perhaps a mixture of that Spanish event-risk and the ECB’s ongoing QE saw to it that Bunds had a bid behind them (10-year at 0.39% yield, -4bp), while Gilts also managed a better bid, with a 1.35% yield (-3.5bp) at the close on the 10-year issue. The US Treasury closed offering a yield of 2.42% (-4bp, 10-year).


Busy, busy, busy

We’re in for a busy period now. President Trump is expected to declare his hand and nominee for the chair of the Federal Reserve, we have the FOMC to look forward to (no change expected) while the BoE monetary policy committee is also gathering (+25bp?). Apple, Pfizer and Kraft Heinz amongst others are due on the earnings front and we close out with non-farms on Friday. After the close on Friday, S&P affirmed the UK’s rating (at AA) and upgraded Italy (to BBB). As if to highlight that the cycle might be showing signs or returning to normal, it was revealed that Akzo Nobel had made an approach for its US competitor Axalta Coating.

£550m deal for the Liverpool-based multi-brand online retailer

In credit, the new issue market also had a couple of interesting deals. In the euro-denominated market, Saipem Finance printed a long 7-year for €500m which was priced to yield 2.625% and took the monthly HY total to €13.6bn, leaving October as being one of the best months on record for HY issuance. The annual total is now up at almost €62bn and we must be looking at a €67- 70bn context for the full year.

We’ve already smashed the previous annual record which was €57bn in 2014. The other deal of note was the £550m issue from Shop Direct. The borrower had gone out for £700m but met with fierce investor pushback on dividend payout concerns and reduced the size of the deal while paying a higher coupon in the process of 7.75% (up from 7%). We view that as good news although this kind of dynamic is likely more possible in the UK market owing to its smaller, more concentrated investor base.

There was nothing from the IG market in the session with the monthly total at €18bn and the annual one at €228bn. These are both less than we expected.


Looking ahead

It is early days, but the euphoria around equities comes at an interesting point. We’re close enough to year-end for investors to be thinking about asset allocation decisions for 2018. If the US tax reforms got through largely as presented then there is little doubt that US growth is going to sustain a minimum of 3% and it will lift the global economy with it. US equities are also going to be setting fresh record highs and that will lift other markets, too. Policy rates will go higher and market yields too.

Why bother with fixed income in 2018? After all, as we suggested earlier, returns will decline once the rate cycle shows a sustained returns to normal policy. Capital preservation strategies might become less prevalent or less needed sometime next year, and investing for growth (capital appreciation) might start to see some of the rotation trade start to kick in.

That’s not necessarily bearish for credit immediately. After all, corporate credit metrics are going to improve and demand will stay fairly robust during the early stages of it. It might be the case that by the time we are confident that the economic/rate cycle is normalising we are already thinking about 2019’s allocations. So we must be looking for much tighter spreads from here and a maintaining of the status quo – yield investing still works.

As it happened, we had a much quieter session in cash markets on Friday. The Markit iBoxx IG cash index closed a basis point tighter at B+100.7bp and this is the lowest level we have seen this year. The index is now just 7bp away from its record low.

In high yield, we had barely any movement, but the index was marked a basis point higher (surprisingly given the stock moves) at B+264.5bp and we saw a similar move in the CoCo market although for the latter, there might have been some concerns over the Spain situation. The index market traded as we might have expected. iTraxx Main was 1.4bp lower at 51.4bp and X-Over tighter by 4.5bp to 232.6bp.

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.