12th February 2016

The St. Valentine’s Day Massacre

MARKET CLOSE:
FTSE 100
5,537, -136
DAX
8,753, -264
S&P 500
1,829, -23
iTraxx Main
126bp, +9bp
iTraxx X-Over Index
486bp, +31bp
10 Yr Bund
0.18%, -5bp
iBoxx Corp IG
B+192.5bp, +5bp 
iBoxx Corp HY Index
B+662bp, +19bp
10 Yr US T-Bond
1.64%, -3bp

Still we don’t throw in the towel… We haven’t capitulated yet, but we are working on it! X-Over heading to 500bp isn’t good, but it isn’t capitulation. Equities falling 2% a day with odd days of respite – over a period of weeks – is unwelcome, but it also isn’t capitulation. Credit spreads going higher isn’t capitulation either. If there’s order in the weakness, it isn’t capitulation – more perhaps a sustained bout of panic. Everywhere one looked, the news was bad. Poor earnings reports saw an unforgiving market hammer individual names as the likes of Tate&Lyle and Societe Generale took a pummelling. Bund yields up to intermediate maturities hit record lows while the 10-year at 0.16% was 11bp off its record low from a year ago (0.05%, closed at 0.18%). And that’s before we consider further QE from the ECB. Panic, a calculated move to put its currency under pressure or just ahead of the curve in a beggar-thy-neighbour cut, the Swedish Riksbank slashed its deposit rate to -0.5% from -0.35%. Treasury yields in 10-years dropped to 1.55% (-12bp) at one point and the equivalent Gilt yield fell to a record low of 1.27% (closed 1.28%). That’s all relatively good news for performance for fixed income total return investors (see chart). IG corporate bond returns are still amazingly in the black YTD (+0.05%), even though spreads have gapped 40bp in the last 6 weeks (see chart). Obviously the rally in that underlying is responsible for total return money investors’ bounty in corporate bond markets, and this positive figure also goes someway to explain the lack of significant outflows from the asset class. There’s little alternative in terms of income generating assets, and while that’s never a good reason to promote an asset class, the current ills elsewhere should help to promote the defensive nature of solid, plain vanilla corporate bonds. Usually, if credit funds experience outflows the money goes to government bonds for safety or equities for better future upside (cycle has turned). The former offers nothing given the negative/very low yields, while the latter likely offers huge volatility and capital losses and extreme uncertainty. With this unusual, disjointed macro-economic and strained systemic structure we currently face, IG corporate bond investments promise to preserve capital and generate some income. That is, the best of both worlds – or the best of a bad bunch.

Fixed Income: The Ultimate Defence

Fixed Income Ultimate Defence

 

If it looks bad, it’s because it is… Deutsche Bank’s CDS rose to 280bp (+35bp, closed 270bp) and is materially higher than levels seen in 2008 (175bp), while still short of the record high 320bp seen as the Greek crisis peaked back in 2011. The 6% coupon CoCo fell to below 70c (-6 points) on the dollar and Wednesday’s bounce in the bank’s stock, CDS and bonds was over in a flash. The DAX fell below 8,700 briefly, before managing to stage a recovery and ended only 2.9% lower at 8,753 (-264) while French stocks, as seen through the CAC index, fell 4% with losses accelerating into the close. Oil prices fell with WTI at $26.1 per barrel and Brent holding $30 per barrel – just (it will soon give way too and converge on the WTI price). Main rose to 126bp and X-Over to 488bp at the session wides. Cash was marked wider again as any bid was there solely to miss. The chief beneficiary was perceived quality – government bonds and gold prices rose. 10-year Treasuries ended the session offering a 1.64% yield (2-year UST+99bp). In Europe, the 2-year Bund was at a record low yield of -0.55% and yields were negative all the way out to 8-years. Peripherals gapped with the Portuguese 10-year up at 4.06% (+38bp), Italy at 1.71% (+8bp) and Spain at 1.77% (+6bp). We can’t help thinking that there is more downside to come and we’re not just hostage to any immediate headline anymore. There’s a battering ram of poorer macro to come as the opening two-months of weakness in markets feeds into the real economy. February’s data, albeit backward looking when published, will only serve to quite possibly presage more weakness through March.

Credit markets beaten too, but putting up a fight… The markets generally tried to rally mid-session, but gave up the battle into the close. The DAX/€ Stoxx 50 are now down a massive 18.5% YTD. The FTSE and S&P have also been clobbered. IG euro/sterling corporate bond returns in investment grade are flat YTD. While junk bonds get a bad press, they are “only” down 3.3% YTD and the low default rate in Europe means they are still paying coupons pretty much everywhere. The bad press around them is unwarranted, but we can understand they supposedly make a good headline. Remember, many HY entities managed to get much finding in during their good years (2011-2015) and the refinancing wall has been pushed out to 2018. Unless the Eurozone economy literally falls off a cliff, they’re going to be money good. The only asset classes beating corporate bonds are precious metals and government bonds. The IG Markit iBoxx corporate bond index closed at B+192.5bp, almost 40bp wider YTD and some 5bp wider in the session. Yuk. In HY, it was worse with a B+662bp iBoxx index level into the close (+19bp, almost +140bp YTD) as illiquidity, low flows and fear all weighed on the sector.

What next? Wait until Monday. Have a good day and weekend. Back soon.

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.