8th February 2016

Read all about it

MARKET CLOSE:
FTSE 100
5,848, -51
DAX
9,286, -107
S&P 500
1,880, -35
iTraxx Main
116bp, +11bp
iTraxx X-Over Index
423bp, +17bp
10 Yr Bund
0.29%, -1bp
iBoxx Corp IG
B+179bp, +1bp 
iBoxx Corp HY Index
B+609bp, +3bp
10 Yr US T-Bond
1.84%, unch

Negative corporate bond yields – Naah… The theme running through the markets at the moment is around sustaining economic competitiveness through currency devaluations; it is being driven by (central bank) interest rate cuts – and in some cases it is about taking rates deeper into negative territory. Back in Q1 2015, buying into the euphoria ahead of the ECB’s original QE announcement, it seemed that there was a real prospect of some euro-denominated corporate bond yields going negative – where else was there value as the 10-year Bund yield dropped to 5bp?! There is precedence. Given the history and prevalence of retail investors in Switzerland (as well as the peculiarities of the Swiss franc market), they are – misguidedly – buying negative-yielding corporate bonds. We don’t see any sense in it, and we certainly do not foresee any prospect of it becoming commonplace elsewhere. It’s topical again in euroland as the macro newsflow worsens and the currency strengthens (or the dollar weakens against it), leaving us edging closer to ECB “action day”. Two-year Bund yields are at -0.50%, the 10-year is heading lower (at +0.29%) and demand for safe-haven fixed income assets naturally turns heads towards the corporate bond market – and not just the double/triple-A sectors. Government bond yields go negative but still manage to find buyers because banks need to buy government bonds and other (negative-yielding if it happens) SSA paper for risk-weighting purposes, given that they are assets which fit the LCR bucket. Bank are a captive audience, so to say. For anyone else, simply don’t do it. Better put the cash under a mattress. Now we might get to the stage where yields will drop precipitously – even from these levels – if deflation becomes deeply rooted across the eurozone (late 2016, 2017?), and corporate bond prices will be bid up in that search for yield (à la Q1 2015). That would mean getting used to a lower corporate bond yield environment again. That seems like a distant prospect right now, as they’re actually heading in the other direction, with the Markit iBoxx IG corporate index yielding 1.8% compared with 1.02% a year ago. For non-financials, we saw a low yield level of 0.99% in Q1/2015, while the front-end double-A index yield is now at around 0.16% versus a low of 0.11% back then (see charts below). For funds, it is third party money that is being managed. If returns are negative then investors will pull their money out – or they should. On the macro side and longer term, if deflation sets in corporate credit quality will eventually come under pressure: that will impact the default rate as rating transmission risks increase, and sentiment towards the asset class will take a knock. Before that happens, don’t forget event risk. The mattress it is.

Corporate Yields by Rating Category

Corp Index Yields by Rating

1-3 Year Non-Financial Yields

Front-End Corp Index Yields by Rating

Non-farm payroll report leaves everything to play for… Stocks sharply lower, Treasuries sold off and, after a non-farm/unemployment print and not knowing anything else, that would mean a rate increase is on its way. Classic economics. However, at 151,000 jobs created – lower than the 190k consensus, albeit with the unemployment rate below 5% – we think the print was bit indifferent. It was not low enough to blow the potential rate hike for 2016 out of the water, but nor was it high enough to suggest one is definitely coming soon. It does add to the gloomier data we have seen out of the US these past couple of weeks, though. Our view is for no hike in the first half, as the Fed will consider global conditions and the impact any additional tightening would have on extremely jittery global markets. Anyway, we ended the week just as we played out the rest of it – nervous and weak. Choppy and then sharply lower global stocks, nervous credit (quiet in cash, considerable weakness in synthetics), oil in a tight range for once and other (corporate earnings) newsflow not great. It looks like we are set up for another difficult open today, given the accelerating losses into the close in the US last Friday.

Corporate bond market refuses to panic… When all’s said and done, we can only hope to put the US rate situation to one side and get some stability on markets so that, in credit, we get more supply to aid a bit of confidence. Spreads played out in a tight range through Friday’s session and were only moderately higher in the whole week. Commodity paper bounced hard (several points), but when stocks are rising as they did for the likes of Anglo, illiquid corporate bonds will do the same. The Markit iBoxx IG corporate index closed at B+179bp, just 5bp wider in the week. While non-financials have held up well, financials are coming under intense pressure and scrutiny. The weaker economy and poorer earnings (particularly for those with investment banking franchises) are resulting in some severe price action. AT1 paper (especially Deutsche’s – but they are not alone) has been hammered. In high yield, we closed out 3bp higher for the Markit iBoxx index at B+609bp and just +14bp for the week as a whole (B+630bp is the index wide from mid-January). There have been outflows – especially in some retail funds, over the past few weeks – but the market is handling that quite well. On the flip side, there is certainly demand for risk: we just need primary. Last week saw just that and took the total IG non-financial issuance, year to date, to €8bn. And there is enough of a pipeline to possibly take us over the €10bn mark with a flourish, and not limping over that line. That will obviously depend on macro, stocks, sentiment, oil and the dollar. Amgen, Honeywell, LyondellBasell, United Tech are the US corporates in the throes of roadshows, while we are absolutely sure European entities will be looking for their moment (no need for them to telegraph their intentions). HY supply has moved up to €1.2bn after several small taps last week.

The numbers look dire… iTraxx Main closed 5bp wider at 110bp and X-Over at 422bp (+16bp) illustrating the severe risk-off nature of the session. These are easily the current contract wides. The secondary corporate bond market has a much different technical dynamic and pretty much closed, but in primary, Schlumberger managed to get a €600m deal away. In equities, the DAX was at 2016 closing lows, and some 14% down this year already! The level of bond yields everywhere might be signalling a recession to come – but bond yields are also at these very low levels because of mass market manipulation by central banks (QE, in other words).

To end on a happier note, the Credit Market Daily welcomed its 1000th sign-up last week. Back tomorrow, have a good week and be very careful out there.

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.