30th November 2015

Stand and deliver

MARKET CLOSE:
FTSE 100
6,375, -18
DAX
11,294, -27
S&P 500
2,090, +1
iTraxx Main
70bp, +0.5bp
iTraxx X-Over Index
291bp, +1bp
10 Yr Bund
0.46%
iBoxx Corp IG
B+151.7bp, unch 
iBoxx Corp HY Index
B+476bp, +-6bp
10 Yr US T-Bond
2.22%

Draghi and his chums will deliver… After all, when the wallahs at the ECB take stock, they ought to see a eurozone economy struggling to break free from the shackles of deflation, with little material credit growth in the right areas leaving a difficult outlook for sustainable growth prospects; but also a world fraught with an increasingly tense geopolitical order. China is in the throes of a multi-year rejigging of its economy at just about the wrong time as far as the rest of the world is concerned. The US can and will (we believe) go it alone for a while, but might need to do an about turn some time in 2016. And the eurozone is simply in the doldrums. This is when consensus politics needs to come together and do the right thing. The markets are telling the ECB that it needs to deliver on December 3 – or else. Government bonds are certainly positioned for further easing in some format, with front-end yields hitting or parked at record lows on a daily basis. Likewise for the stock markets, which have recorded an impressive recovery of late. Credit isn’t necessarily “positioned” for it, in the sense that we don’t think there will be a major investor-driven sell-off derived from a significant reduction in risk if the ECB does nothing. There will be sell-off in government bonds, equities will head south and credit spreads will in the main be marked wider. Few will sell, as rebuilding positions will be expensive if not impossible. Nevertheless, the hard-won recovery in performance since the tragedy of August/September could be lost in a flash and returns slashed through what would be a difficult December. That is because in thin markets, which December will provide, the marginal buyer (tourist money) might scramble to get out while still ahead. This would exacerbate the downside in a battle-weary market with wafer-thin liquidity. We however prefer to remain optimistic, and Draghi has usually delivered. That means the current boom in the stock market will continue, government bond yields will fall some more – with the 2-year Bund possibly visiting -0.55% – and credit spreads will tighten through the Markit iBoxx B+150bp level for IG corporates (finally), leaving benchmarked corporate bond returns easily in the black for the year as 2015 draws to an end.

Good month for corporate bonds… We closed out last week just a little better, with higher beta risk gaining most. There were no deals in primary, but the month turned out to be a decent one with some Eur24bn getting done in IG non-financials, according to Dealogic data (sixth best month this year). We think the primary market will stay open for another couple of weeks. It’s been a decent month for the corporate bond market from a performance perspective, and for those total return players in particular. They needed it! IG returns YTD are now positive at +0.2%, which might not seem like much but it’s a good reversal after being down -0.6% a couple of months ago. Spreads are 40bp wider in the year to date though, as measured by the Markit iBoxx IG corporate bond index. In IG, November returns are +0.8% and spreads have only tightened a couple of basis points, as the focus has been squarely on the primary bond market. In HY, spreads have tightened 6bp in the month, returns for November are also around 0.8% and YTD the HY bond market has returned a touch below 3%. We had targeted annual returns in IG of 2-2.5% and for high yield of around 4-4.5%. The sell-off in the Bund from those Q1 levels has not helped the IG market (longer duration), while the HY market has benefited from the anchoring of the front end of the government bond curve.

Squeaky bum time until December 3… That it will be. We’ll all be looking for clues into that Thursday meeting. But in reality, there will be no big advantage for anyone, we believe. Not to forget the non-farm payrolls report which be released on Friday. There is a rate hike coming in the US two weeks later. This looks priced in now, and should help markets stay on the front foot into the end of the year, albeit in extremely thin markets.

Have a good week.

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.