- by Suki Mann
|🇩🇪 10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|🇺🇸 10 Yr US T-Bond
|🇬🇧 FTSE 100 7017.88, (-1.94%)||🇩🇪 DAX 12790.49, (-1.88%)||🇺🇸 S&P 500 3128.21, (-1.50%)|
Credit on a roll…
We are barely six weeks into 2019 and we have an almighty squeeze occurring in spreads in the corporate bond market. Investment grade spreads have tightened 20bp (iBoxx index) while the solid support for the underlying has meant that we have already managed total returns of 1.5%. The high yield market, supposedly going to suffer from the macro slowdown this year, is experiencing a squeeze of its own with the iBoxx index 49bp tighter and returning 2.8% year to date. The sterling market is performing the same as the asset class across the board finds a very good level of support. And we can’t even point a finger at the manipulative impact of the ECB’s QE bond buying.
The levels of corporate bond issuance has disappointed overall. January might have been a super month in the primary market after a swathe of SSA, covered and IG corporate bond issuance but in the case of the latter, it’s not been enough. Interestingly, we are ahead of last year in the supply stakes, but the full-year total came in almost 30% lower than the average of the 2014-2017 period.
The demand for paper has been at a high level and sustained throughout, with a particular bid for higher beta (IG) risk. Year to date has IG non-financial issuance at €28bn with just the Iberdrola hybrid offering so far this month. Most issues are tighter versus reoffer and that underpins greater confidence in the market. We have only had €2.8bn of high yield rated issuance – from four borrowers.
Rates are low and the prevailing view is that they are going to stay lower. As we suggested in Wednesday’s comment, benchmark 10-year Bund yields are at 0.16% for a reason. The incoming data has been corroborating the view that we are now in a sustained economic downturn in the Eurozone. This is no soft patch.
The latest news release had new factory orders decline by 1.6% month-on-month in Germany, or 7% year-on-year. The mighty auto industry is suffering (Daimler’s fourth quarter operating profits fell 22%) while the trade conflict between the US and China is likely going to accelerate the decline in the export sector. The ECB is sitting it out at the moment, and letting events play out. But a messy Brexit is a non-trivial probability and there will be a greater macro impact which will lead to a slump.
Why does credit work? Debt metrics will be exhibiting some downside and the weakness will see rating transmission risks increase. But low funding rates and copious levels of hoarded cash, allied with a reduced funding wall will keep the default rate at low levels for this stage of the cycle. Fundamentals will remain largely intact. Low underlying market yields and cash needing to be put to work amid a massively lower free float of corporate bonds (after the ECB hoovered up €178bn of IG corporate bonds), means that technicals are also supportive. The squeeze must go on.
Santander and a huge sigh of relief
The credit market was cock-a-hoop, well, more precisely, the CoCo market was. And that came about because we had an AT1 issue from Santander. It mattered because of the small question of whether they would be calling their upcoming AT1 debt, due next month. There had been some apprehension that the economics of the call would leave the bank to pass on it, but the $1.2bn PNC5 7.5% issue will have helped to allay much of those fears. It gave the whole CoCo market a boost.
Elsewhere in new issues, we had euro-denominated primary focused exclusively on SSA deals and covered bonds. Of course, Italy’s return to the market (16-year maturity, €10bn deal in January) for a long 30-year maturity deal was the focus with a record €40bn+ of orders for the €8bn offering. They’re getting the funding in while the going is good and judging by the level of interest, investors have few qualms about the potential economic and political event risks besetting the sovereign. So another blank in the corporate bond market.
In secondary cash, we didn’t see too much by way of activity with flow and volumes at low levels, but we did get another big squeeze in spreads. The Markit iBoxx cash index in IG tightened by 3bp to B+152.1bp and there seems like no stopping this massive performance we’re seeing at the moment. Relief in the CoCo market saw the AT1 index tighten to its lowest level of this year, to B+607.6bp (-15bp) and 102bp tighter for the opening weeks of the year.
The high yield market also squeezed, landing at B+475bp for the index at the close (-6.5bp) with little sign of a decent deal imminent (€125m DiGi Communication tap possible this week).
As for the iTraxx synthetics, given that slight weakness in stocks, the rally in protection markets stalled and we closed with a moderate back up in spreads, Main closing 0.4bp higher at 69.8bp and X-Over just 2.2bp higher at 306.7bp.
The Dax eventually closed 0.4% lower, the FTSE was a shade in the red while the S&P was also moderately weaker. Those poor German factory output numbers were the main news item on the macro front, but we did have some unstatesmanlike inflammatory language from the EU’s Donald Tusk that would have hardened the Brexiteers stance against the EU. An acrimonious split is now getting closer.
Rates closed better bid and we ended with the 10-year Gilt benchmark yielding 1.21% (-2bp), the US Treasury in the same maturity 2.68% (-2bp) with Bunds a basis point lower in yield at 0.16%.
Have a good day.