21st March 2016

‘Spring’board to a brave new world

MARKET CLOSE:
FTSE 100
6,190, -11
DAX
9,951, +59
S&P 500
2,050, +9
iTraxx Main
Index roll
iTraxx X-Over Index
Index roll
10 Yr Bund
0.21%, -2bp
iBoxx Corp IG
B+155.8bp, -0.5bp 
iBoxx Corp HY Index
B+544bp, +2.5bp
10 Yr US T-Bond
1.87%, -2bp

We can but only hope… There are still seven trading sessions to go either side of the Easter break and much to be garnered from them before the quarter is out. We’ve had a super recovery in risk asset valuations. Draghi had talked down the prospect of further easing while subsequently Praet effectively ruled nothing out. It has been this way for so long – actually since the crisis began – that one would be forgiven in thinking that it is deliberate policy to have us all confused as to when or what the next fix will be. There’s always been a next fix. The market was buoyed by the latest dovish words which helped push risk assets better into the end of last week, while we see no reason why we can’t continue this way for the foreseeable future. In corporate bond markets anyway. The euphoric reaction to the ECB easing almost two weeks ago has dissipated and we have consolidated, absorbed €30bn or so of corporate bond debt of every ilk and are ready for the next slew of issuance. Bad news will not derail us, just halt the spread tightening trend for the periods that equities, for example, exhibit any volatility. As a reminder, we don’t believe that the latest ECB actions will do the trick and bring the Eurozone economy out of its low/no growth-related slumber. Credit growth will remain subdued while inflation will struggle to rise much higher than where it currently resides. The latest producer price drop (for February) in Germany of 3% YoY (-0.5% MoM) is a blow and highlights the predicament facing policy makers and politicians alike. Eight years into the current slump will become ten – or maybe more. That’s why, barring an (unlikely) economic or financial system cliff event, we are of the view that a medium term strategy of investing for income and capital preservation (corporate bonds) while avoiding as much as possible the volatility associated with macro and headlines risks (equities), is a way to play it. Looking for the economy to blow not too hot, central bank action if we go too cold – even Goldilocks would be happy. The story though is around stocks at the moment, and equities have been on the front foot the past two weeks, while the two months prior had been devastating for them. US stock markets are back in the black for 2016, and the DAX is still down 7%.

What do we know?… That the US economy is blowing more warm than cold air, that likely two rate hikes are coming and the stock market will probably play out higher into it. The Fed is cogniscant of the global risks but likely has an eye on the dollar and will probably look to generate some sort of sustainable recovery and higher inflation by needing the dollar to stay relatively weak. The Eurozone is really struggling. The ECB has pretty much kitchen-sinked it and now needs structural reform and a fiscal boost to complement its own QE. They won’t get that, and if they did it would take years before the impact of them were felt. More or continued weakness therefore in the Eurozone is a reasonable expectation. That means easier policy through the rest of this decade, asset bubbles, lower bond yields, uncertain equities and tighter/lower/compressed corporate bond spreads and markets. As for Asia, we rely here on China and as much as we need the economy there to restructure to a domestic-demand driven one and away from being export related, we can only hope things don’t go awry as that multi-year dynamic unfolds. Unfortunately, the risk is skewed towards hitting another brick wall somewhere. Net net, the global economy remains in a precarious state, competing policy actions (currency wars and so on) leave it as every man for himself, while the volatility derived from inefficient markets on low volumes are likely going to become the norm. Finding an asset class which can largely weather all that – defensive but with some upside – leads us to IG investment grade bonds. Quelle.

Don’t despair at the consolidation… One would be forgiven in thinking that the steam had run out of the corporate bond market in double quick time. After all, the euphoria which greeted the announcement of the ECB’s bond buying programme (from us too) dissipated after two sessions. But believing that would be missing the small issue of needing to absorb a huge amount issuance through last week, which normally would have seen spread widen aggressively. Instead, from Monday’s open to Friday’s close, we ended 2bp wider, while from Friday-Friday we tightened 4bp. And new issues have performed very well. The HY market has moved in similar fashion, tighter in the Fri-Fri period, but wider in Monday to Friday. The Markit iBoxx index yields have fallen though to 1.45% and 5.20%, respectively, for IG and HY. We should get another big boost to spreads once we know the details of the bond buying programme, while until then, we continue to look for a steady grind better.

New contracts for the synthetic indices… For the iTraxx index techies, we roll into the new contract with Glaxo, Renault, Heineken and Technip all entering Main Series 25, while Anglo American, Rentokil, Casino and Repsol wave goodbye. Into the new X-Over contract come Alstom, Anglo American, Casino, CMA CGM, Elissa, Garfunkelux, GKN, Metro, Repsol, Smurfit Kappa, STM and UPM-Kymmene. The X-Over leavers are Alcatel, Cerved Group, Lufthansa, Grupo Isolux, Metsa Board, Nokia, Portugal Telecom, R&R, Rallye, Renault, Tui and Unilabs. The opening session for the indices will be about repositioning into the new contract with little gained in terms of how the levels might be influenced by macro events.

 Have a good week.

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.