5th July 2016

ECB – more effective than a Dyson

MARKET CLOSE:
FTSE 100
6,522, -56
DAX
9,709, -67
S&P 500
2,103
iTraxx Main
80bp, +1bp
iTraxx X-Over Index
347bp, +1bp
10 Yr Bund
-0.14%, -2bp
iBoxx Corp IG
B+149bp, -2bp 
iBoxx Corp HY Index
B+494bp, -7bp
10 Yr US T-Bond
1.44%

ECB hoovering up the market…

It is making a clear statement: we are serious, don’t mess with us. We are going to dumb this market down to zero.

The ECB reported that the first three weeks of monetary operations that took in the corporate bond purchase programme has seen it lift €6.8bn of the market. That’s a monthly run rate of around €9bn and if it manages to sustain it for a year, it will have hoovered up more than €100bn of IG non-financial corporate bonds. Well over 90% of the total is from the secondary market, of which we calculate eligible debt of €660bn. If it hasn’t already, it will soon dawn on market participants that this is a serious amount of paper being taken down by the ECB – and it is corporate bond risk that will not re-emerge. That is, there will be no forced selling by the central bank. The aim of the programme is for investors to take on MORE risk – sinister as that sounds. That is, fund smaller corporate, lower-rated corporates and get involved in smaller deals.

We will also soon come to realise that we ought not to sell to it – as tempting as its bid might be. Replacing the debt is going to be more onerous as the months pass. Don’t kiss your bonds goodbye – and that includes any unfancied holdings. Competition in primary is only going to intensify. New issue premiums are going to fall even further. Borrowers are going to be the chief beneficiaries – if they need to raise funding. Otherwise, they can afford to wait – and we think they should, given that reinvesting their booty will also come with its own side-effects.

We thought that anything north of €2bn a month would be a result. A €9bn monthly run rate, even at this early stage, is great work and mightily impressive. And we’re not even sure if it has just lifted the low-hanging fruit. It is reducing the size of available bonds in the market and there will be an impact on the asset management community (not enough debt to round). As frustrations intensify, spreads will soon have to start to crunch tighter. Yields are already closing in on last year’s record low index yield levels (1.02% Markit IG corporate iBoxx), while spreads are still 50bp wider. Still, performance of 4% in terms of total returns for the IG market (YTD) is excellent – and some consolation, and will be sustained through this year. We can all worry about next year in due course.

Last chance saloon

We probably have three weeks of activity tops before we close out for the summer. ASML was out of the blocks with a dual tranche €1.5bn offering which was priced 15bp inside initial guidance, on combined books of almost €8bn. It gives hope that receptive markets will take up the potentially heavy volumes we can expect, which previously may have been curtailed as a result of the caution on the back of the Brexit and Fed/ECB meetings in June. The month of June only saw €11bn printed in IG non-financials, following on from a stellar €45bn+ in May.

The US Independence Day holiday made for a very quiet session overall, but corporate bond markets were again recording tighter spreads as they recovered some more of their post-Brexit losses. Stocks moved to the downside, but that is understandable after the massive rallies witnessed for most of last week, while government bond yields were anchored at just above their lowest yield levels established last week. News flow was light save for some ECB loan-related stuff around Italian banks – or rather Monte dei Paschi, which came under pressure as it was ordered to reduce its NPLs; S&P warned on UK recession risks (quelle surprise), while construction activity fell off the proverbial cliff in the UK in June. Spanish unemployment continued to decline rapidly, with the overall unemployment rate dropping to below 20%.

The 10-year Gilt yield was unchanged at 0.84% (-2bp), the equivalent Bund yield was lower at -0.14% and there was also little movement elsewhere with BTPs at 1.24% and Spanish Bonos yielding 1.14%.

Corporate spreads recover

The Markit iBoxx index for IG corporates dropped below B+150bp, to B+149bp and 2bp tighter in the session. The index yield also crept lower, to 1.10% and closing in on that 1.02% record low from Q1 last year and with it all, returns are rising. At B+494bp (-7bp) for the index, the HY market is similarly on good form and we continue to believe that this risk-on moment for the market has much legs in it. And that was all against the backdrop of a weaker equity market although there was little really to get in the way of the tightening trend given the limited activity on the back of the US holiday. The iTraxx indices closed slightly better bid (wider) with Main at 80bp and X-Over at 347bp, which was to be expected given the weakness in stocks.

It’s all good. 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.