28th March 2018

There may be trouble ahead

MARKET CLOSE:
iTraxx Main

61.5bp, +1bp

iTraxx X-Over

290.1bp, +3.3bp

10 Yr Bund

0.50%, unchanged

iBoxx Corp IG

B+108bp, +0.7bp

iBoxx Corp HY

B+336bp, +2bp

10 Yr US T-Bond

2.79%, -1bp

FTSE 100 , DAX , S&P 500 ,

Emerging markets to lead the way, again…

It’s not lost on us that USD 3-month Libor has doubled in the last 12 months from 1.15% to 2.30%, and it is going to heap (if it isn’t already) much pain and misery on dollar funders, especially. Refinancing – which tends to be shorter-term in Asian markets, is going to be a major headache for borrowers in the region (defaults WILL increase).

Right now it seems to be a slow-burning fuse but it threatens an explosion in Asian/Latam credit market losses especially, and will likely unleash an uncontrollable contagion impact which takes in other corporate bond markets.

Europe might be buttressed to some extent – for a change – given the region’s growth dynamic (in some sort of recovery), the defensive balance sheet posture of most major entities (liquid), and the still low refinancing costs which feed into an investor base still willing to fund them. In addition, the flight to quality trade (haven away from stock market weakness) has seen a drop in swap rates here, such that the 5-year euro swap yield is down at 0.36% versus o.50% a couple of weeks ago. The 10-year Bund yield is just 6bp higher at 0.50% this year, owing to the current rally which has seen it drop from the 0.80% reached in early February.

There’s no throwing in the towel – or necessarily reducing credit exposure per se, because rebuilding them will be expensive. Maybe we will see some reallocation to lower beta risk until the storm passes. But getting some protection on board to hedge out the risks might be a more efficient and less expensive way to manage any upcoming carnage. For now, though, global growth might be slowing, but euro credit has some safe haven characteristics, the ECB is wary of it all and might well have to stay (QE) accommodative into and through year-end.

It’s turned out to be a very difficult quarter for the markets and worse than the opening, oil price ravaged opening three months of 2016 in some cases. We almost kicked-on in fine style during Tuesday’s session, but gave up as the US session entered that final furlong. And with just one session to go before we close for business into the long Easter weekend, we’re sitting on some serious losses in stock markets.

It has actually been a shocker for stock markets, in every sense. It wasn’t long ago that we were thinking of the S&P500 in the context of a 3,000 level, being barely 2% away from that target. All the omens were that we would see out that figure this year as US and global growth, boosted by the US tax reform and ramping up of the investment machinery were pointing to it.

Even the potential US/North Korea summit was positive. Unfortunately, addressing the gargantuan trade deficit in the US – and with that comes with it, has added much fear into the markets. Some were already nervous that markets were overvalued. The US/China spat – albeit showing some containment at the moment – might still be the straw that breaks the camels back.

Credit as such is saved from the worst of it by the rally in rates (for total return investors), while benchmark investors have also performed relatively well. Credit market investors can thank the ECB (QE), a poor primary market in IG non-financials, and a European corporate asset class which still bears an attractive underbelly of support from stable fundamentals (macro, defaults, still limited deleveraging and transformational M&A).


Primary the credit story for Q1

With Thursday likely going to deliver very little or nothing in primary as we head into the Easter break, we can look back on the quarter as being a very poor one for the primary markets. IG non-financial issuance at a little over €54bn has been extremely poor and down by a massive 40% versus the same period in 2017 (€88bn). Spreads should be materially tighter given this fact and that we know there is massive demand still for paper – even if it is mainly through a willingness to add only in primary. After all, the ECB is lifting close on €6bn a month and mainly through the secondary market  – with the haul expected to reach €150bn when next week’s figures are released.

It’s inexplicable that spreads are not materially tighter. Just based on supply/demand dynamics alone, we should be at or close to those record lows seen 7 weeks ago, not moving away from them, even if there is a much trepidation running through equities on macro/geopolitical event risk issues.

As we wrote in Wednesday’s note, the level of high yield primary activity at €19bn has surprised to the upside and runs ahead of Q1 last year (at €16.3bn) by some margin. Last year saw a record €75bn of issuance in this market. Our target for this year was set at between €55-60bn and it now looks as if this level will be deemed too low.


Choppy penultimate session of the quarter

There was little respite in Wednesday’s session, with markets continuing to trade out in very uncertain fashion. The S&P whipsawed between being up 15 or so points and then being down by the same amount. European stocks tried to gain some positive momentum during the short intraday periods when US stocks were in the black, but ended lower and the Dax index, for example, approaches the end of the quarter looking to be around 8.5-9% lower (970 points lower YTD at close of business).

Toyota Finance: €500m deal

The macro news flow in the session had US GDP come in at 2.3% for 2017, and at a revised higher 2.9% for Q4. The US yield curve flattening to a 10-year low at 49bp for 2s/10s would be suggestive usually of a recession to come. However, while this might be the case historically, the crisis-era monetary policy has had an unknown manipulative and distortive effects on how the economic cycle might actually play out.

Duration caught a decent bid throughout the session, with Gilts particularly in the ascendancy and the 10-year yield lower by 6bp at 1.36% (+10bp in the quarter and off a high in Q1 of 1.70%, mid-Feb). The yield on 10-year Bund closed unchanged at 0.50% while that of the US Treasury declined a touch to 2.79% (-1bp) having been down at 2.75% earlier in the session.

In credit, we had just the single deal – the first for just one a week, from Toyota Finance Australia for €500m priced at midswaps+23bp for €500m and off a book at just €650m for the low double-A rated borrower. That’s not great and the fizz just seems to have gone out of the market.

In secondary, we’ve essentially shut up shop, but we had more weakness in the market. The Markit iBoxx IG cash index closed a touch wider again, at B+108bp (+0.7bp). The high yield market proffered little, except for a little weakness with the index at B+336bp (+2bp).

For the indices, iTraxx Main was up at 61.5bp (+1.1bp) and X-Over at 290.1 (+3.3bp).

Have a good Easter.


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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.