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|🇩🇪 10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|🇺🇸 10 Yr US T-Bond
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Funding needed for the wall…
Good riddance to May. Unfortunately, it looks as though it is going to be an even more difficult June given that the issues which affected us last month are likely going to have a more serious impact through it. May’s performance data will show we scraped through with just a few scratches (in credit anyway), but the real deterioration is possibly only beginning. Just as well markets everywhere had a very good January – April period and handily managed to bag much performance, because we’re going to rely on it from now.
There is no mistaking Trump’s economic rampage against those he feels have wronged the US is about to erupt into something more fierce. Unless he is reined in.
The increasingly acrimonius US/China trade war is our biggest concern. That Trump has now turned his ire on Mexico imposing 5% tariffs on all Mexican imports into the USA from 10 June is going to add to the sense of gloom, as the US uses her economic might to fight various battles. Elsewhere, we still have EU politics to contend with including that UK Conservative Party leadership battle and all that holds for Brexit. While the EU is going into battle with Italy on those budget issues and fraying many a nerve as it does.
So those macro pressures are thumping away. China’s manufacturing sector contracted in May according to the latest official PMI which came in at 49.4 versus expectations of 49.9, and against a reading of 50.1 in April. Domestic employment indices were also impacted highlighting the increasing pressure on the workforce. German data showed a slowing in inflation in May to just 0.2% versus a 1% rise in April and in the US, the personal consumption expenditures (PCE) index rose by 1.5% with the core level at 1.6% year on year, well below the Fed’s 2% target rate.
As the fear gauge rises, it will translate to lower activity as well as weakening levels of investment and demand – and they’re going to need a pick-me-up. Alas, Draghi is on his way out as his term in office wingds down but can he leave the markets with another dose of medicine from the ECB’s cabinet to help the patient limp on? As for the Fed, they will stay pat for the moment but we’re not sure for long they can, interest rate cuts are coming.
And so we take note of the declining bond yields in the US and Europe. We’re now contemplating a 2.00% yield for the 10-year US Treasury having seen it crunch lower to 2.16%. In the meantime, the -0.20% record low yield for the 10-year Bund has been met and we set a new intraday record low yield of -0.213%. Must we be thinking that -0.25% is quite possibly this week’s business?
Looking at May’s performance, risk markets across the board let off some steam, and in credit, it was the first monthly performance reversal this year. Euro-denominated IG credit delivered total returns of +1.1%, +0.7% +1.4% and +0.7% in the consecutive months January to April, but reversed the positive trend in May albeit with losses of just 0.2%.
For the year to date, few are going to quibble with returns residing at +3.7% – but we’re going to need the buffer they offer as we head into a potentially difficult summer period. Benchmark investors will have found the going a little more difficult in May, with IG spreads (iBoxx index) 23.5bp wider and now left with just 27.5bp of tightening in the index in 2019.
High yield investors might feel aggrieved possibly, in much the same way. January to end April recorded monthly total return performances of +2.1%, +1.8%, +1.4% and +1.3% before a loss of 1.3% in May. Obviously the strong correlation with equities has been a factor because we haven’t necessarily seen much evidence of material investor de-risking in the asset class. Still, +5.3% year to date would be happily taken if it was the performance for the full-year. Index spreads have widened by 65bp though in May leaving just 60bp of tightening year to date.
Sterling IG corporate credit has played in line with euro-IG in spread terms but aligned with high yield in total returns (iBoxx index) owing to the longer duration (7.8 years) of the asset class – and helped by the rally in the underlying (Gilts), perhaps disproportionately. Spreads on the index have widened by 19bp during May but total returns have risen by 0.3%. Total returns for the year to end May come in at +5.5% on just 18bp of spread tightening.
Eurozone rate markets have been the big winner in May with returns jumping from +2.5% in the January to April period, to 3.6% for the first five months of the year.
The S&P had a volatile month and lost 6.5% courtesy of it, but still manages to hold on to gain of 9.6% for the year to end May. Surprisingly, the Dax only lost 5% in May but is the best performing stock market for the year in the five months to the end of May, perched up with total returns of 11%. The FTSE has gained 6.5%, the Dow 6.4% and the €Stoxx50 11%.
Primary slows into the headwinds
Of course the headwinds we encountered through the final week of May put paid to any hopes of a good week in primary. That is, we are unlikely going to see much change at the beginning of this opening week for June and quite possibly beyond.
Still, IG non-financial issuance for the month came in at €30.15bn making May the second best month of the year so far. The only deal in the final week came from Illinois Tool Works which issued €1.6bn in a 3-tranche transaction. And that 3-tranche deal was the fifth such offering in the month, while we have had well-over 10 this year so far.
The other big takeaway for May and the year so far is the volume of issuance from US domiciled borrowers. They account for 35% of the issuance year to date – or €44.4bn, and 40% of May’s issuance. Typically, we might expect anywhere in the order of 12-18% for any given year.
So for the year to end May, we have had €127.3bn issued in IG non-financials, which has us in line with the medium term average and sets us on course for around €250bn for 2019. However, the deterioration in macro and rising geopolitical concerns might see a continued lull in the level of issuance through June and the summer months. This could set us back materially with borrowers reluctant to come to the market and investors demanding greater premiums for providing funding.
The high yield primary market also felt the full ramifications of the weakness in markets through much of May. The last week of the month saw only one deal printed and that came from Norske Skog for just €125m. After almost €10bn was printed in April, we dropped back to just €5.29bn in May from 8 borrowers.
The year to date total moves inexorably on, to €25.6bn and would normally have had us on course for somewhere in the region of €50bn for the full-year (€62bn last year). The current unfavourable developments in macro might just see high yield issuance undershoot that €50bn target.
Senior financials issuance drew a blank in the last week, which is understandable given that the only deal in plain vanilla investment grade markets was that from Illinois Tool Works. The month’s senior debt transactions though were decent at €11.75bn and for the full-year we’re up at €73bn. It’s tempting to extrapolate and think we might get somewhere in the order of €150bn for the full-year, but issuance tends to slow from now and the trajectory suggests we’re looking at €120bn – €130bn for the full-year.
A taste of things to come
Trump is doing his utmost to wreak havoc across the markets. Nevertheless, we recovered a little from the worst levels in the week’s final session. It’s little consolation and the Dax eventually closed 1.5% lower, the FTSE -0.8% and the US indices by up to 1.4% and at around their worst intraday levels.
In rates, the 10-year Bund yield clawed a basis point back from its intraday record low to close at -0.20% (still -3bp in the day), the Gilt yield edged 2bp lower to 0.89% in the same maturity and the Treasury yield was 5bp lower at 2.17%. This was about scrambling for safe-havens amid escalating event risks.
Over the weekend, the leader of Germany’s junior coalition partner, the Social Democrats, announced her resignation. This plunges the future of the SPD and the Christian Democrats (led by Merkel) into some doubt, potentially bringing Merkel’s reign to a premature end. Something possible here to support the current bid for Bunds.
Credit index barely moved in the Friday’s session. Main closed at 71bp while X-Over only edged higher to 307.2bp (+0.8bp). That will change this week.
In cash, the market drew in its horns and the defensive stance was reflected in the lack of a bid and therefore the lowest levels of activity. It left spreads wider, but nothing alarming in the final marks. The IG iBoxx cash index was left at B+144bp (+1.5bp) and the HY index saw 10bp of widening to B+464bp. The next moves are going to be completely dictated by events as highlighted above.
As for this week, Trump is still on the road and stops by the UK, where Theresa May finally steps down from government on Friday. The ECB meets midweek with the latest policy decision due on Thursday and of course we are expect Draghi to say risks are clearly to the downside etc., but additional, immediate policy action will not be coming just yet.
We close out with the non-farm payroll numbers for May where the economy is expected to have added 183k jobs (236k in April) and the unemployment rate is expected to stay unchanged at 3.6%. Average hourly earnings are expected to have ticked up a touch in May to 0.3% from 0.2% previously.
Have a good day.