28th November 2016

The natives are restless

MARKET CLOSE:
FTSE 100
6,841, +12
DAX
10,699, +10
S&P 500
2,213, +9
iTraxx Main
81bp, unchanged
iTraxx X-Over Index
340bp, -1bp
10 Yr Bund
0.24%, -2bp
iBoxx Corp IG
B+140bp, +1bp 
iBoxx Corp HY Index
B+447bp, +6bp
10 Yr US T-Bond
2.36%, +1bp

Nervous times for corporate bond markets…

November has become the cruellest of months for corporate bond market investors. The sell-off in rates has followed through into spread markets and performance has been battered as a result. Having survived a weak January and February, recovered strongly in the period from March to October, we are about to record the first negative month for performance since those opening months. Investors are fretting because it looked so good just three weeks ago! As measured by the Markit iBoxx index, IG credit has lost 0.95% and spreads have widened 18bp in the month so far. That is incredible and completely unexpected. At least rate markets have found a new level (it seems) with benchmark 10-year Bund yields residing in a 0.20-0.30% range. We can’t say the same for credit. The cash IG index is now up at B+140bp and only 14bp tighter year-to-date.

In a sense, we would think that the ECB’s ongoing corporate QE programme has become a godsend because €44bn+ of ECB bond-buying will have stemmed much further weakness in spreads. But such are the vagaries of our market – fear, illiquidity and so forth – that a decent chunk of selling will always elicit disproportionate price action. Hence why almost €2bn of weekly corporate bond accumulation is probably only slowing the widening in spreads seen this month.

Furthermore, the high yield market hasn’t quite been a beneficiary of the ECB’s IG interest as we had previously thought it might. That is, the push down effect from crowding-out dynamics hasn’t happened. That’s because investors have been happy to sell into the ECB’s bid, content to sit on their hands and wait for IG supply to emerge. High yield spreads on the iBoxx index are 37bp wider this month but even when the going has been good, the index level has failed to break the 400bp barrier. Mind, we’ve been up at B+670bp this year, so the market has recovered well. HY has lost 0.9% in performance so far this month which is better than IG, but benefited from being a shorter duration asset class.

There’s a much better dynamic around the sterling corporate bond market. It’s much smaller and the audience is more concentrated. Big funds dominate and ALM type of investing strategies dominate. £500m of weekly corporate bond QE by the BoE makes a much bigger difference. Index spreads have widened just 5bp this month, to G+160bp and that is despite a quite major sell-off in Gilts and much uncertainty around what a post-Brexit UK economy might look like.

So what do we think? We’re unfortunately not going to go much tighter. Being so close to year-end and with Trump inaugurated in January, we believe investors will be looking to protect whatever they’ve managed to garner this year. There’s too much uncertainty and potential for volatility. So 4% total returns in IG and 6.6% for HY (both year-to date) would represent a good year’s work. While a few will be disappointed that we are off the 6.2% and 8% highs respectively, they would have taken the current returns back in January.

On to the next holiday – Christmas

The markets almost have a clear run now until the Yuletide break given that they still need to manoeuvre a couple of hurdles. The first is the Italian constitutional reform referendum, although we also have the delayed head of state elections in Austria (both on Sunday). A defeat for Renzi in Italy and a win for the Freedom Party in Austria and the message to the global markets will be loud and clear. That is, political change and a different reform mandate is coming in more than just the UK (Brexit) and the US (Trump). A few days later, the ECB close out their thinking for 2016 and expectations (we think) for 2017; They’re bound to extend the current QE programme for at least another 6 months.

The non-farm payroll report comes on Friday and the consensus is looking for 175,000 jobs to have been added. Anything around this number will make sure that a US rate hike will come at the December FOMC meeting. Today, we get the Black Friday retail spending numbers from various outlets. What’s the betting records were broken, everywhere?

So we go into this week with the 10-year Bund yielding 0.24%, the 2-year at a record low of -0.77% and the UST-Bund 10-year differential at a massive 212bp. Italian yields will be quite volatile this week and play out to each and every headline with the 10-year at the moment sitting at 2.08% (-4bp on Friday). Spanish yields are following Italy higher and currently are at 1.57%. Corporate bond spreads from the periphery will likely be as equally volatile especially banking and insurance risk.

That’s it. Have a good Monday.

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.