4th April 2016

Fool if you think it’s over

MARKET CLOSE:
FTSE 100
6,146, -29
DAX
9,795, -171
S&P 500
2,073, +13
iTraxx Main
74bp, +1bp
iTraxx X-Over Index
305bp, +1bp
10 Yr Bund
0.13%, -2bp
iBoxx Corp IG
B+151bp, -2bp 
iBoxx Corp HY Index
B+529bp, -10bp
10 Yr US T-Bond
1.77%, unch

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With bated breath, here goes…

A new month/quarter starts proper and we have much to look forward to. It really has all the hallmarks of a new chapter for the corporate bond market. This one is not going to pass by without much speculation, comment, perhaps volatility and above all opportunity. In our corporate bond world, the ECB will be the standout institutional influence on how the period/year and even the long-term structural dynamic pans out. The central bank could well be rewriting how we view corporate bonds as an asset class.

The Fed comes second for the moment, in our view. The data were very promising in the US towards the end of last week, and rate speculation is back on. We still think there’ll be nothing doing there in April. The excitement therefore is here, in Europe. We have to face up to the fact that the ECB has set the cat among the pigeons with that corporate bond purchase programme announcement – whether we see it as necessary or ill-thought out. So getting on with it means that short term it is great (tighter spreads, lower yields, boosted returns), but long term it’s a case of frustration at market liquidity, annoyance at the level of the market and a bit of pain from not being able to lift enough paper and having to take on a disproportionate amount of risk.

Be careful out there

We have been eulogising about corporate bonds, but we got off to a weak start for the month. It didn’t help that Japanese stocks tanked after the Tankan survey (-3.4%), because this gave Europe its cue. We opened lower and continued to drop through the session, with falls of 0.5-1.7% registered. Anbrentd then European data was mixed, but surveys suggested we’re in for a long hard slog. The latest March PMI data showed that the Spanish manufacturing sector slowed, while in Italy manufacturing activity ticked higher but unemployment worsened. Doubts around the oil production freeze – kind of ‘tentatively’ agreed a few weeks ago – saw to it that prices fell and Brent was left at just under $39 per barrel (-3.25%).

In the US, the non-farms report was excellent (suppose that depends how one is positioned), although the jobless rate ticked higher as the participation rate increased. Those data set off a chain reaction – rate expectations rose and the dollar rallied a little, while stocks initially moved lower only to close out slightly better. The reception to Tesla’s new car order book likely electrified a few into action.

Corporate bonds, just watching them go

  Spreads (bp)  Yield 
Market Index1 Jan1 Mar1 Apr|1 Jan1 Apr2016 High
Investment GradeB+155B+184B+151|1.76%1.37%1.90%
High YieldB+526B+634B+529|5.18%5.05%6.43%
Senior FinsB+113B+140B+120|1.22%0.98%1.26%
Subordinated FinsB+279B+357B+316|2.97%3.02%3.76%
Corporate HybridsB+426B+524B+446|4.48%4.32%5.52%
CoCosB+594B+868B+778|5.94%7.43%9.68%
Sterling CorporatesG+180G+239G+196|3.88%3.67%4.15%
Source: Markit iBoxx

Trawling through the monthly spread and index yield performance data, IG corporate bond spreads have tightened 18% or 33bp to B+151bp (Markit iBoxx index). They’re only 3bp lower YTD and the index is yielding 1.37%, which is a level last seen in May 2015 and compares with a March 2015 historic index low of 1.02%. That 1.02% record has to be in sight.

The HY index crunched 105bp in March to B+529bp, and the yield dropped 95bp to 5.05% in the same period. Here we are far off the April 2015 low of 3.67%, but again it is not impossible we might get close to it in due course as IG and other investors get crowded out by the ECB. We’ll know more soon enough. The potential for that massive crowding out impact and a ratchet lower in yields will force the hand of investors into riskier paper. That might just be ‘senior’ HY debt, but we think subordinated debt from IG borrowers will gain much too. Here, corporate hybrid spreads have managed some recovery in March, with the index spread dropping to B+446bp (-70bp) and the yield by the same amount to 4.31%, which is still substantially higher than the 2.35% hybrid index yield seen a year ago.

The CoCo bond market might not be so straightforward in its recovery dynamic. The potential for supply, product structure and ongoing regulatory dabbling will all likely weigh on the asset class, but in the search for yield, some desperate or irrational decisions/positions might be taken! The Markit iBoxx index CoCo yield has fallen to 7.43% (-84bp in March, -200bp off the highs) but has some way to go to those halcyon days of a year ago when we touched 4.95%. Place your bets.

But how much primary?

In order to demonstrate that investors might already be thinking ahead, it’s worth reflecting on the Akzo Nobel deal of last Friday. The issuer took €500m on 10-year funding at midswaps+70bp off a book of almost €6bn. Initial price talk was 95/100bp and the ratchet tighter in final pricing reflects the demand for the borrower’s paper. AkzoNobelThe mind games (wide IPTs) from the syndicate desks in order to elicit the required interest were unnecessary given that we thought the Akzo name would have been an ‘easy’ sell, even if it was pre-NFP. After all, Akzo is a rock-solid European industrial company and a fairly infrequent borrower. The deal was finally priced pretty much flat to the curve.

For April and the second quarter, it is going to be difficult to judge how much issuance we might get. Normally, it is the second best quarter of the year with much funding done ahead of the summer before we get a decent pick-up in issuance in September through to November. This time though, the ECB is likely going to skew the market and the natural expectation is to see a slew of funding get away at low costs – while they last. This time though – those low costs are going to last for a while, and we don’t need a crystal ball to make that observation! So, wait until you need the cash, or get the cash on board anyway?

That’s it for now, back tomorrow.

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.