- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
|FTSE 100 7,769.14, -9.50||DAX 13,200.51, -44.52||S&P 500 2,786.24, +18.68|
2017 on the wane, but it shone brightly
It has been a fantastic year for all risk assets classes. Equities have been on fire. High beta corporate bond risk has had one of its best years. Investment grade credit has defied gravity – and the sceptics.
Duration risk has made a sterling recovery after a weak first half as rates have failed to push on into improving macro metrics. On macro, it appears that super accommodative central bank policy has finally stemmed the despair we have endured for the best part of a decade, with some semblance of stability and a positive growth trajectory.
From improved growth dynamics in 2018 will come much food for thought in terms of asset allocation and for investor expectations for returns. The new kid on the block is ‘crypto’ and once the hype fades, Bitcoin is going to face a make or break year; It could genuinely be transformational.
As for 2017, the here and now has us reflecting on a very good year. We’ve had our more difficult moments. Political and geopolitical event risk have been a feature, but corporate bond markets have remained resolute. We’re closing out after a quite vicious sell-off in November from record tights in some higher beta credit sectors.
But we have since stabilised at still tight levels when taken for the year as a whole – some would suggest rich ones – and only the usual year-end feeling has prevented markets from moving on. We are all set up (hopefully) for the usual positive start to 2018, which ought to carry us through the first quarter with little fuss.
The performance of the credit market has actually been superb given how ‘rich’ valuations were already perceived to have been. The Market iBoxx IG cash index was marked at B+134bp as we turned the page into 2017, and currently resides at B+98bp (4bp off the record tights and 3bp off this year’s lowest level).
The bullish projections would have been for the index to tighten to B+115-120bp area, but the 36bp of tightening has been excellent. That’s a total return on 3% year to date for IG credit for those who were indexed and running a beta of 1.0. Few were doing that and will be looking at returns way in excess of that figure, and more than double as portfolios will have significant allocations to high yield debt.
In the high yield market, spreads currently reside at B+300 for the iBoxx index, some 50bp off the record tights we saw several weeks ago. But that is still 133bp of index tightening and total returns year to date of 6.2%. Anything around the 5% mark was where the most bullish expectations would have been, given we would have needed rate markets to have been kind. Well, rate markets were, but the ECB’s €130bn+ of IG debt purchases played a major part in crowding out IG investors of their markets and effectively forcing them into this one.
With that push down the curve, the contingent convertible sector was probably the corporate bond market’s greatest success story of the year. We had a couple of ‘events’ but that failed to dent the appetite for risk of this asset class and Nordea managed to print an AT1 deal with the lowest coupon seen of just 3.5%.
The demand for yield only increased as the year progressed, investors gained confidence that a banking sector recovery was well-entrenched and that the potential for a significantly important financial institution to get into difficulty so as to make not good on its contingent obligations was unlikely. Returns passed the 17% mark and spreads on the index tightened by 283bp. Most investors will have seen returns of 20% (or more).
There was some rotation out of non-financial high yield corporate bonds into the CoCo market, supporting this asset class further especially after the first half. We think that we might see further upside in the product through at least the first half of 2018, even if much of the low-hanging fruit has been picked.
The sterling corporate bond market has also had a very good 2017. Gilts were choppy throughout and at times cut into the total returns, but the rally of late has boosted performance to 4.5% on spreads tightening in the index by 18bp. We’ve had to endure much uncertainty around the Brexit debate/negotiations and political uncertainty, while the UK economy has been blowing more cold than hot with high levels of inflation seeing to it that the BoE raised rates by 25bp.
So overall, from a performance perspective, credit market investors can be very satisfied with their efforts this year.
Primary markets finally deliver
We were concerned during the summer months that the issuance in IG non-financial corporate bond risk was running lower than expectations, given that the low funding levels on offer amid massive demand for assets might not be with us for a whole lot longer. Having barely reached €200bn in issuance as we came out of the holiday period into September, the markets perked up with a final flurry which ended with €25bn+ of supply in both September and November.
As it happens, the near €266bn YTD puts us right in the middle of the pack in terms of supply in this market over the last 4-years (range being €259bn – 271bn).
Just like on the performance front, the success story for 2017 has to be the high yield market. Not only have we managed to garner a super level of performance, but it has come despite the record level of issuance. That is, the massive supply of over €75bn – which busted the previous record of €59bn seen in 2014 – had no bearing on performance.
Demand has remained at very high levels despite reduced inflows (which have been directed more to IG funds of late) and borrowers have not been shy in coming forward to get their funding needs away. It is very difficult to predict what we might expect for 2018, especially if rate markets start to see yields back up. But with the ECB on hold for the whole of next year (likely), a limited rise in market rates might only have a small impact on issuance trends. We don’t expect another effusive year on the supply front, but if this fledgling asset class loses that ‘fledgling’ tag, then another €50bn+ might be on the cards.
Central banks done for 2017
This week was all about the central banks and they duly delivered what the market expected without exception. The Fed hiked by 25bp (and suggested 3 hikes likely in 2018), the ECB and BoE left it all alone. The ECB’s asset purchases continue until at least September 2018 in reduced format (€60bn to €30bn per month).
The new forecasts for growth were raised to 2.3% and 1.9% for 2018 and 2019, respectively from 1.8% and 1.7% as the Eurozone benefits from a broad-based global expansion. As for inflation, we are looking at 1.4% in 2018 (from 1.2% forecasted in September) and an unchanged from previous forecasts 1.5% in 2019.
Inflation is going to be the key in all markets in 2018. The very fact that it has failed to rise much more in the US or Eurozone this year, despite the firming up in growth, has kept rate markets under control. The so-called smart money in 2017 was for sharply higher rates (on the back of higher growth and inflation), but that trade failed miserably. Surely, in 2018, we must expect inflation to exceed expectations, especially if economic growth remains firm. That would mean higher market rates (in the first instance).
Slow end to the day
For now, we do not expect anything untoward now until year-end and would think that the markets will trade out in rangebound fashion though the holiday weeks. That is certainly how it has been through the opening couple of weeks of the month and both volumes, flows and secondary market liquidity are going to fade markedly from now.
The data in Thursday’s session had US retail rise by a sprightly 0.8% in November versus October and ahead of expectations which were pitched at 0.3%. Euro-area PMI came in at the highest level for almost 6 years at 57.5, further adding to the belief that the region’s growth dynamics are being built off solid foundations.
Wrapping it up, we had a mixed session for government bond markets with Gilts better bid such that the 10-year benchmark yield fell to 1.17% (-4bp) while the good numbers in the US weighed on Treasuries and yields there rose to 2.37% (+2bp, 10-year) before settling close to unchanged at 2.36%, and Bunds closed the day with yields a basis point lower at 0.31%.
US stocks were trading flattish before ending up to 0.4% lower ( we’re not sure why, maybe tax reform concerns?), while European ones were up to 0.7% in the red. US markets have had a blistering year up by well-over 20% for the Dow and 18% or so on the S&P with all of the indices in the US setting fresh record highs in the process. The DAX has been the leading light in Europe, up almost 14% in the year to date.
Finally, in credit, the iTraxx indices continued to trade in tight ranges, just like they have been for all of December. iTraxx Main ended 0.2bp higher at 48.0bp and X-Over edged 2.1bp higher to 236.0bp.
In the cash market, primary drew another blank and secondary was its usual very quiet self. Spreads barely moved and played out in very tight ranges as a result. That left the Market iBoxx IG cash index at B+98.4bp and the index level has not moved for over two weeks now. In high yield, weaker equities meant the market was slightly better offered for choice, the index left at B+302bp (+1.3bp).
We wish all our readers a joyous Christmas period and a prosperous and happy new year.
With the exception of something major happening between now and the end of the year, we’re closing out 2017’s commentary and insights into the corporate bond markets and will be back on 2nd January (along with MiFID II!). Issuance data will continue to be updated so you won’t miss a thing.
Dr Suki Mann
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