- by Suki Mann
|🇩🇪 10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|🇺🇸 10 Yr US T-Bond
|🇬🇧 FTSE 100 6144.25, (+1.26%)||🇩🇪 DAX 11657.69, (+1.33%)||🇺🇸 S&P 500 3036.13, (+0.74%)|
Can’t blame it on the Brexit…
The Eurozone is still in crisis. Just as we suggested previously, the ECB came out with additional policy accommodation. Although rates were left unchanged – we think moving on them is politically more difficult – the potential rise in interest rates was pushed back to 2020, and the central bank unveiled a new series of long term refinancing operations (TLTROs). Basically, cheap loans for the Eurozone’s banks in an effort to help support growth.
None of that ought to have come as a surprise, given that the macro outlook has been looking particularly bleak for a while now. The region’s economy has barely hauled itself out from the previous downturn and is again plunged into another. And the growth downgrade for 2019 was nothing short of brutal.
The markets reacted as we had previously suggested that they might. The low rates for longer mantra means… eventually equities will gain some support, we will get lower bond yields immediately and amid tightening in corporate bond spreads – so long as macro cliff-risk is avoided.
The ECB continues to push on that string and the incentive to restructure (debts) is pushed back into the distant future, if it happens at all. Until the politics change and the tough decisions are made, the ECB has little choice but to keep the liquidity taps open. As such, the moribund economy is almost now totally reliant on stimulus. And as the central bank feeds the fish, asset bubbles continue to inflate. Still, we can sit back, and enjoy the returns we’re likely going to muster through this year.
It’s not as if we needed a trigger to load up some more in credit. But the latest ECB move suggests the outperformance in higher beta credit is going to continue. AT1 markets and other hybrid or subordinated corporate bonds which offer incrementally higher levels of yield are going to remain in the ascendancy.
The high yield market will come in next, but we might detect some apprehension to pile in aggressively given that the macro risks might see a rise in the default rate and other event risks for single names. Nor is there a marginal buyer as we had previously when the ECB’s QE programme crowded IG players out of their traditional markets and forced them to add HY risk. In support, the funding wall is pushed back so we might detect less desperation from borrowers needing to get financing in.
So overall, it’s back to the pre-ECB QE era. Don’t we just love a crisis. We are going to see credit perform and deliver returns in excess of 2% for this year (in IG), while the AT1 market will deliver upwards of 5% and the high yield market over 4.5%. It’s time to feel more confident about increasing beta allocation. Long AT1 (yield hogs) and short bank equity (lower profitability) seems to be the trade for the moment.
Lest we forget, borrowers are going to enjoy cheap funding too for a while longer. Whether this elicits a fresh splurge in borrowing and capital markets activity is an unknown given that issuers will be well aware that they can bide their time in accessing the markets. There’s no rush.
Fixed income is where it’s happening
The ECB slashed all inflation and GDP forecasts for 2019, with more moderate cuts for 2020. Quelle. For 2019, they cut growth expectations to 1.1% from 1.7% previously and for 2020, a smaller revision saw them reduce growth forecasts to 1.6% from 1.7%. On the inflation front, it’s 1.2% for 2019 from 1.8% previously and in 2020, its 1.5% from 1.6%. With that, news later emerged that Eurozone production contracted in H2 2018, and for the first time since 2009.
Equities tossed and turned, before heading lower as the ramifications of Draghi’s words and the ECB’s actions sunk in. The outlook has deteriorated some more and equities will play to the tune of the incoming corporate earnings data while supported by the excess liquidity in the system. The Dax closed 0.6% lower, the FTSE 0.5% and US markets were off by around 0.5%, as at the time of writing.
We didn’t quite see 0.20% on the 10-year Bund yield last week, but we got very close. The next stop looks like 0% with a 6bp drop alone during the session to 0.07% (0.061% intraday low). We’ve seen -0.12% back in 2016 on the 10-year yield when yields turned negative in the period between late May and September. We would think that record is safe for the moment – likely needing fresh QE to get us close.
Rates received a firm boost in the session, the 2-year Bund yield a little lower at -0.53% and the 5-year at -0.39% (-4bp). Gilt yields also tumbled, the 10-year to 1.16% (-6bp) while elsewhere the BTP dropped to 2.48% (-14bp), with the Spanish 10-year edging towards the 1% barrier for the first time since 2016, now at 1.05% (-7bp in the day). The US Treasury market was also better bid, the 10-year yielding 2.65% (-5bp).
In credit, primary in euro-denominated corporate land was quiet, but Vinci did get £800m in an equally split 8-year and 15.5-year offering, at G+123bp and G+133bp, respectively. Books topped £3bn and final pricing tighter by 17bp versus IPT. Secondary was quiet and the initial response of the Street was of caution, leaving IG spreads better offered and the iBoxx index a basis point wider, at B+147.1bp. The massive rally in the Bund pushed IG total returns, year to date, to 2.25%.
The higher beta CoCo market closed unchanged while in the high yield corporate market, spreads were a touch wider leaving the index up at B+455bp. Index followed equities with iTraxx Main up at 63.1bp (+1.8bp) and X-Over 8bp higher at 285.8bp.
Have a good day, US payrolls are up next. I’m back on Tuesday.