3rd February 2019

Credit spreads squeeze, again

MARKET CLOSE:
iTraxx Main

71bp, +0.2bp

iTraxx X-Over

309.9bp, -1bp

🇩🇪 10 Yr Bund

0.17%, +1bp

iBoxx Corp IG

B+159.4bp, -1bp

iBoxx Corp HY

B+488bp, unchanged 

🇺🇸 10 Yr US T-Bond

2.68%, +4bp

🇬🇧 FTSE 100 6185.62, (-1.55%) 🇩🇪 DAX 12993.71, (-0.71%) 🇺🇸 S&P 500 3373.43, (+0.12%)

Recession risks loom amid a need for yield…

Forgive the pun but, unfortunately, January is not a dry run for the rest of the year. We were hit with a raft of disappointing data on the opening session of February (non-farms payrolls aside), and the stage is set for it to continue – likely leaving us with much more volatility (and weakness) through the rest of the first half of 2019 at least. Just as well we have plenty of performance in the bag from January – across all markets, to help cushion some of the blows which might be coming our way. They’re going to come. Because we knew we were heading into a soft period, and the numbers are now confirming that. Eurozone inflation is slowing, manufacturing activity across Europe is slowing (or in contraction) – and the same goes for China and the US (to some extent).

In credit, there will be a need to stay relatively defensive but investors will chase yield – where it makes sense to do so. Rates are going to stay anchored around these levels or head lower if the deterioration in the macro environment leaves global growth in recession territory. We’re not there yet, but it isn’t going to take too much for that technical recession.

As we know from the past decade, a recession or a long period of low growth doesn’t necessarily mean a catastrophe for corporate bond markets, like it might have done in a more textbook, classic sense.

Primary has not been as effusive as it might have been in previous years for a January, with levels of issuance lower in bank and high yield debt markets. IG issuance has been a little more sprightly. However, the generally overall lower levels of deal flow have offered support to secondary and spreads are squeezing.

We are looking for just 10-15bp of spread tightening in credit this year. We’ve had a good start where that performance has been reached, but heading into the next few months, we can expect some weakness because deteriorating macro is going to impact equities. Any volatility there will find its way into the credit markets. Nevertheless – and unless we have a major disruptive event, credit can play out in a B+150bp – B+180bp range (iBoxx index, currently B+159bp).


Heading into a brick wall

Few seemed to get excited about the consensus-busting January payroll report.  The headline figure was excellent with 304,000 jobs added n the month against expectations of 165,000, but the number was sullied by the revision to December’s 222k additions (as 90k was lopped off it). Average earnings increased by 3.2% in January (3.3% in December) while the unemployment rate rose to 4% from 3.9%.

There was a little bit there for everyone. The labour market in the US remains solid, wage inflation moderated and the unemployment rate just edged a touch higher. In itself, it won’t alter Fed policy and we will need to see another couple of months of data before we can think that it might change. For instance, January’s US manufacturing sector rebounded following weakness in December. No one was cock-a-hoop, equities were choppy but managed to gain some motive traction eventually while rate markets were better offered.

In Europe, we had a raft of poor PMIs from various jurisdictions following China’s weak Caixin report overnight and that set the tone for a subdued close to the week. Apprehension, though, is going to build because the Italian situation is again getting much by way of headlines. Business conditions worsened in January as the manufacturing PMI dropped to 47.8 and smashed through the 48.8 expectations, and way off the 49.2 level recorded for December. Don’t forget, we had already seen Q4 GDP contract by 0.2% and by 0.1% in Q3 leaving the country in a ‘technical’ recession.

Right now, Europe doesn’t need an angry UK, but playing hardball as they are, a no-deal Brexit is on the cards.

Anyway, the Italian markets were the underperformers in Friday’s session, as we would have expected given the growing economic concerns. Equities in Italy lost 0.8% while other markets were mostly higher, and the 10-year BTP yield shot higher to 2.73% (+14bp). Elsewhere, rates were better offered, the 10-year Bund closing at a yield of 0.17% (+1bp), the Treasury at 2.68% (+4bp) and the Gilt closed to yield 1.25% (+3bp).

Equities generally didn’t too much in the session, and we closed flattish across most markets as investors took in the various bits of economic data prints during the session. The FTSE outperformed (+0.7%). Credit synthetics closed unchanged as well, although the indices did close strongly on Thursday. iTraxx Main was left 71bp (+0.2bp) and X-Over 309.9bp (-1bp).

The deal flow in credit on Friday was in sterling. VW was back for £350m in a long 4-year and Santander took £1bn in a covered bond. For the week, we had just €4bn of IG non-financial issuance, from two borrowers (Telefonica & BMW), €575m in high yield from Smurfit and Autodis while just two issuers delivered €1bn in senior financials.

In the cash market, IG credit was a touch better for choice amid little flow and volume and we closed the session with the iBoxx index a basis point tighter at B+159.4bp, representing. 6bp tightening int the week – and around 12bp since the beginning of the year. The high yield market closed unchanged (B+488bp) and the AT1 market was a little better offered for choice.

As for this week, Trump will finally make his State of the Union speech but it is not going to move the markets. The BoE monetary policy committee meets and will leave everything unchanged. The earnings season at the halfway stage for the US sees the likes of Alphabet, Twitter and GM report while the Asian lunar year break will keep Asian markets out of the limelight.

Have a good day.


Suki Mann

A 30+ 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 CreditMarketDaily.com.