9th July 2017

The only way is up

MARKET CLOSE:
iTraxx Main

57.3bp, +1.3bp

iTraxx X-Over

257.6bp, +4.6bp

10 Yr Bund

0.57%, unchanged

iBoxx Corp IG

B+110bp, +0.25bp

iBoxx Corp HY

B+302.6bp, +9bp

10 Yr US T-Bond

2.39%, +1bp

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Past the inflexion point…

It’s been a difficult couple of weeks for the markets and we’re left with much to ponder as to how we will fare through the summer months and the remaining half of this year. The weeks straddled either side of the half-way mark have been the most difficult for a while.

Benchmark 10-year Bund yields, for example, have almost trebled. With that, a long hot summer beckons and we might be in for a torrid period for fixed income markets. That’s what we ought to be reading between the lines which take in the macro outlook (improving), rate markets (yields rising), equities (lower and higher volatility than we have been used to) and geopolitical risks (North Korea mainly).

The money at the moment looks like it is on economic recovery in the Eurozone but with little sign of a major increase in inflation – so interest rates stay unchanged, QE runs through to year-end in its current format and the ECB-elite talk, coax and cajole the markets into adjusting for the next major announcement.

The US economic outlook is more mixed, but there is upward momentum and another rate hike is coming soon – likely the last for 2017, although some will anticipate another into the end of Q4. Rate markets are adjusting. Some adjustment has already occurred, but if economic recovery in the US/Eurozone is sustainable, then rates will push higher through this quarter and next. What looks like a 0.50 – 0.80% range for the 10-year Bund might become 0.80-1.10% and the front end maybe shifting higher, too.

Equity volatility and/or lower equities from here will generally serve to dampen the risk environment which could also mean an end to the ratchet tighter we’ve been seeing in high yield spreads and the steady tightening trend in IG. They will still be better bid but periods of equity volatility amid rising rates will inevitably feed through into spread markets. It’s no death spiral from the contagion, but the best of it might be behind us after that super first half.


The only way is down, for total returns?

At 0.57% for Bund yields and the negative rates on the curve only extending to the 5-year (-0.08%), the rate environment has changed considerably. OATs have backed up to 0.94% (10-year) and Gilts yields have risen to 1.30%. All in quick-fire time. Fixed income returns in the government bond market have resided in negative territory to varying degrees all year (currently -1.9% in 2017, to date) and the pull back is impacting the corporate bond market’s total return performance.

IG returns are now barely in the black (spreads 25bp tighter, iBoxx index), while HY returns look a little more respectable owing to the support afforded to it by the shorter duration nature of the product but also 120bp of spread performance.

While we might get returns coming under some pressure, spread tightening might just offset a fair degree of the weakness. For example, over the past two weeks into that rate market weakness, credit spreads as measured by the iBoxx index have tightened by 5bp in IG and almost 15bp in the high yield market as measured by the iBoxx index.

So, while an improving macro outlook boosts credit fundamentals and should help spreads tighten, we have to offset that against the potential for a re-racking in the multi-asset world in favour of equities (growth). Fortunately, such has been the disruption to the classic model for this to occur following years of policy manipulation of the market, we think there will be little or no evidence for some while of asset rotation.

So, unless the bottom falls out of the market(s) elsewhere, corporate bond market valuations (spreads) have a good chance of being anchored at these levels or going tighter.


Primary looks like the best is over

Are we seeing the first rumblings of discontent as investors push back a little on high yield deals? Much will be made of the pulled deal from Antalis International last week and the weaker pricing (for the borrower) of the RAC Bond Co deal (£275m) as well as the CMA issue, where the borrower only managed to lift €650m and didn’t go ahead with the additional tranche.

The natives will be restless and we can see the headlines now.. “Too many deals, too rich, a deal too far etc”, but we’ve been here before a couple of times this year already. And the Antalis deal won’t be the last deal postponed this year. This comes just when we see the run-rate for high yield issuance suggesting we might be heading for a record year for issuance. This month has already seen €2,225m of deals and the year-to-date figure is up at €36bn. The pipeline is healthy too.

That said, if the last shortened Independence Day/Fed/ECB minutes week is anything to go by, the best might be over for the primary market – until September – judging by the slowdown in deal offerings. While we have had that €2bn or so of issuance from high yield borrowers, the IG market has piped up with only €1.8bn of deal flow, from three borrowers. And admittedly, it’s difficult to judge how this month might turn out although a guide comes from the average issuance of the past three years being €12bn in July.

We closed out last week with cash marked a little wider albeit against low volumes which were apparent all week anyway. IG spreads measured by the Markit iBoxx index were at B+110bp (+0.25bp) and the high yield index at B+302.6bp (+9bp).

We would think that some of weakness in high yield bond marks came on the back of some nervousness and market defensiveness following on from the pulled Antalis deal and the repricing higher of the CMA deal.

This week is a busy one with plenty on the US economic data front including consumer and producer inflation releases, retail sales and industrial production data. We have the US earnings season kicking off, too, with the banks in focus.

Yellen is up in front of Congress while Trump is in France to meet Macron around the Bastille Day celebrations.

One a housekeeping note, holidays mean we will be back with the next daily comment on 21 July. Have a good day.


For the latest on corporate bonds from financial news sources, click here.

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.