27th May 2016

The chosen one

MARKET CLOSE:
FTSE 100
6,266, +3
DAX
10,273, +68
S&P 500
2,090, -1
iTraxx Main
71bp, -1bp
iTraxx X-Over Index
306bp, -1bp
10 Yr Bund
0.14%, -1bp
iBoxx Corp IG
B+147bp, -1bp 
iBoxx Corp HY Index
B+494bp, -6bp
10 Yr US T-Bond
1.82%, -4bp

Life begins at 50…

The markets have sprung back into life this week, but oil hitting $50 per barrel is just a coincidence rather than being the reason for that broad-based risk recovery, we believe. Still, the midweek thrust higher in stocks and oil is very welcome and once again saves performance for many as we come to close out this month. Surprisingly, issuance this week has been muted save for FIG, but with it being the third best month ever for issuance, we will not hold that against anyone. It’s just a lost opportunity given that the lack of competing supply would have allowed for improved pricing dynamics. JC Decaux timed it well. Now, with the Corpus Christi holiday closing many European jurisdictions, the week has ended prematurely, with little to happen until next Tuesday (holiday in the UK and US on Monday).

The big news, though, is the recovery in the DAX index, while the S&P has also pushed on. Safe-haven government bonds have played out in a narrow range, but the periphery has outperformed on news of yet another face-saving deal for Greece. Corporate bond spreads have barely moved in IG – they are a little better in HY, but total returns have held up as the underlying has stayed anchored.

Enel’s exchange deal on Thursday (10-year, €1.26bn) saw supply for May at €42.6bn and confirmed this month as the third best for IG non-financial issuance in the history of the corporate bond market in Europe. It’s also the best May month ever. After the dregs of issuance in a difficult January and February, which between them barely reached €25bn, we’ve now had over €110bn of supply in the March-May period. June is always difficult to predict, as issuance can be quite erratic (€10bn last year but €28bn in 2014, according to Dealogic data) as it’s a pre-summer-break month, but we could expect to see up to €25bn issued into it, given the current dynamics. This begs the question as to what influence the ECB’s bond buying programme might have on supply – not just in June but thereafter, as well as over the medium/long term.

ECB lowers the bar

flagging ECB

ECB: How much can it lift?

We don’t think that the bond buying programme will necessarily provoke greater issuance levels. For sure, some will want to take advantage of tightening spreads and lower yields – and lower funding costs. But for the main part, hoarding even more cash on balance sheets is an unappetising prospect. Cash management becomes an issue as investments to generate returns on that cash are fraught with their own difficulties and event risk. And if we know the ECB is in it for the long term, then we also know that funding costs are going to remain low for the long term. There’s no shifting of goal posts, just a lowering of the bar!

As for how much it can lift, we already commented a while back that €2bn max per month will be the best the ECB could do (and even that will be a struggle). Any trickle-down impact – capital market funding of smaller borrowers – will take time. Lots of it, such that it won’t be apparent through 2016 or in 2017. If its ultimate goal is for this to happen, it will need to show much more aggression early, or it risks being left as a permanent fixture in the corporate bond market. It will likely ultimately become its largest bondholder!

There will be an impact on banks (and the traditional banking model), as the loan market might ultimately also be impacted on any structural shifts in capital markets. The ECB could ultimately more than “Americanise” the capital markets here, should it become too involved. The unintended consequences are significant, the risks unknown, and surely it’s in danger of creating a low-growth, low-yielding eurozone where there will be no exit for the ECB’s QE programme – or at least no eloquent exit. Be careful what you wish for.

Whatever happens, it’s lower and tighter

Corporate bond yields and spreads, that is. This is one of the reasons we have seen such little volatility this year in credit. We know the ECB is rocking up, and to sell would be a mistake for corporate bond asset managers in it for the long term. iBoxx index corporate spreads might currently be stuck at B+147bp (-7bp only YTD, but 40bp lower than their wides of 2016) for IG credit, but we still anticipate them crunching lower once the ECB starts its spree. The size of the initial lifts, as well as how aggressive in pricing it might want to be, will determine how hard we rally. And if it is buying at a consistent level through the drier summer months, we could emerge out of August with spreads on the index trading off a B+120bp-like handle.

Closing out, the DAX ended 0.7% higher with all indices in the black, while the S&P was flattish throughout. It’s been a good week for European equities. Oil fell back through $50 per barrel, but we dare say it will probably rise soon enough. That is, there is no point fighting or second guessing this trend for the moment. For government bonds, the 10-year Bund yield closed at 0.14% (-1bp), while Wednesday’s big winners gave some back. BTPs were up at 1.37% (+2bp) and Bonos at 1.50% (+3%). Gilts had a good session, the 10-year closing at 1.41bp, some 4bp lower. Treasuries were also rallying across the curve with 2s/10s at 95bp.

Corporate bonds had a good time of it too. The lack of supply this week finally seeing some impact on secondary valuations, helped in no small part by the good tone in the market generally. Market iBoxx index IG corporate spreads are now at B+147bp and we would not anticipate much movement in the index between now and month-end. The HY index saw spreads tighten by 6bp while the yield on the index dropped to 4.67% (-8bp) – helped some by the rally in the front-end of the underlying.

Enjoy the long weekend. Back at the end of the month.

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.