10th November 2016

Top Trump

MARKET CLOSE:
FTSE 100
6,912, +69
DAX
10,646, +164
S&P 500
x,xxx, +-xx
iTraxx Main
73bp, unchanged
iTraxx X-Over Index
328bp, unchanged
10 Yr Bund
0.20%, +1.5bp
iBoxx Corp IG
B+127bp, +3bp 
iBoxx Corp HY Index
B+426bp, +8bp
10 Yr US T-Bond
2.07%, +21bp

(Quiet) revolution underway…

The whole shooting match: Republicans have power

It’s all up in the air! The mind boggles. The polls got it so spectacularly wrong again (remember Brexit?). President Trump it will be and the more hysterical (establishment) commentary would have us believe we are plunged into a massive air of uncertainty. Dramatic.

As expected on the back of such a result, the markets dropped hard initially – then rallied off those opening lows in a quite remarkable market recovery. And while the election result is seen by many as a bigger shock than Brexit, that UK referendum before it likely helped immunise the worst the market might otherwise have offered somewhat. So what do we look forward to? Although the Republicans are in complete control (of all the Houses), hopefully some of the pre-election rhetoric is reined in by a more pragmatic advisory team.

From an economic policy perspective, it’s not so clear. The medium and long-term will likely see lower US corporation tax rates, perhaps low taxes for corporates who repatriate their foreign held cash holdings (there’s over a trillion dollars to be brought back). There is the promise of more government spending and with it will come a higher sovereign debt load, higher inflation, possibly sharply higher rates in due course and maybe a weaker dollar. We are also going to potentially be looking at a new Fed Chairperson.

For the next quarter or two, every word Trump utters will be scrutinised to the nth degree, and there is likely going to be significant market volatility. Having said that, the overall reaction of the markets in yesterday’s session was very measured. It was predictable to start in so much that it was risk-off, but volumes were low and asset prices down as traders sought to take a more defensive stance. After all, no one wanted to be hit and accumulate a position that might be difficult to subsequently unwind. Then we saw some stability and we ended the day with most equity markets off their worst levels for the session albeit still in the red, while safe-havens didn’t rally as hard as they might have done despite some initial defensive overreaction.

So what comes next? Show me the money

We go for it to play out as per our opening remarks. The uncertainty will play into the hands of some – fast money will gleefully trade any volatility. US growth stocks (and infrastructure and the like) might be winners, higher US inflation is coming and US bond markets in particular will feel much pressure.

There could be benefits for post-Brexit UK

There could be benefits for post-Brexit UK trade

Never mind 2s/10s, that UST-Bund spread is going to widen more. More government spending leading to higher US growth ought to have a positive impact globally, but previous promises of higher import tariffs might serve to curtail any upside in global growth. Emerging markets might be afraid. That said, the UK will no longer be at the back of the line (queue) in trade negotiations with the US, and a President Trump might actually bolster Brexit.

The markets favourite risk proxy (equities) was under pressure for all but a moment and we know that the market doesn’t usually like change and/or uncertainty, but eventually we will need to look at the risk/rewards associated with higher growth/rates/yields/profits and dividends.

Fixed income, in terms of duration risk in euros should outperform the US, while total returns in dollar credit will erode faster than in the euro-denominated debt markets. The credit to equity rotation trade is a slow burning fuse though, and we ought to keep an eye on flows through the second quarter onwards in 2017.

Finally, don’t forget that there are elections coming up of various kinds in Italy, Germany and France. (Quiet) revolution? Time to believe it.

Primary closed, but relax

It came as little surprise that the primary corporate bond market was closed. However, we would not be surprised if there is a deal or two today – nor would we be concerned if there isn’t anything – this week. Post-Brexit we might have closed in Europe for 3-days (an overreaction), but the implications and potential ramifications of the UK leaving the EU are quite different to a Donald Trump presidency. Still, on a day where markets were extremely concerned, it was always going to be a case of “no deals today”.

The pipeline nevertheless is still rammed. Thanksgiving is two weeks away. There are deals to get done and they will come at a fairly decent pace possibly starting today we think, but certainly by Thursday.

We have to add, much is being made about the lack of post-Brexit/post-US election closure of the primary markets. What’s the big deal? It is not as if a day or two (or even a week or more) of closed markets is going to lead to a funding crisis for any major entity! They’re better planned than that. It is no big deal.

The markets avoid catastrophe, they’re risk on!

A sense of calm transcended the markets as the session wore on – and then we had that stellar close. It might not last once we see Trump’s agenda, but we eventually looked at it all fairly calmly. Stocks might have been 2% lower at the worst point but recovered fantastically and closed sharply higher  – by up to 1.6%! Even US stocks did their bit to help and were materially higher (over 1%). Lest we forget, the dollar recovered all its intra-day losses. It feels like that post-Brexit market recovery all over again.

In a choppy session, Bund yields ended 1.5bp higher at 0.20%, Gilt yields were up by the same amount (1.25%, 10-year) and the rest played out with higher yields, too. We think that it is going to be bad today for fixed income markets in Europe.  That’s because after our close, the Treasury market sold-off hard and the yield on the 10-year rose a painful performance-destroying 22bp to 2.08% with 2s/10s at a stunning 118bp. This was the biggest sell-off in recent memory (well, since 2013). And that’s what a potentially massive infrastructure spending programme does for you. The yield on the 30-year rose 26bp to 2.87%.

And then there was credit. The secondary market stayed under its shell with little doing. But we had spreads under some decent amounts of pressure. That duration sell-off, with fear of a glut of supply of government bonds to come and the prospect of higher yields have the corporate bond markets possibly running scared. The Markit iBoxx IG corporate bond index rose 3bp to B+127bp. After such a super year so far, we’re at risk of snatching defeat from the jaws of victory. Sterling corporate valuations backed up too, the iBoxx index 1.5bp higher. The high yield market moved 8bp wider on a cash index basis, for once not correlated with rising stocks.

iTraxx index closed unchanged with Main at 73bp and X-Over at 328bp. Going forward, does the cost of credit protection follow equity markets or the direction of credit spreads? Higher equities would be suggestive of better support for credit metrics (lower protection costs), but technicals in the latter (outflows) suggest the potential for weaker cash spreads. Lay your bets. More on this next time.

That’s it for the moment. 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.