6th November 2017

Record high/low beta credit compression

MARKET CLOSE:
iTraxx Main

49.4bp, unchanged

iTraxx X-Over

223.5bp, unchanged

10 Yr Bund

0.34%, -3bp

iBoxx Corp IG

B+95.5bp, unchanged

iBoxx Corp HY

B+254.8bp, unchanged

10 Yr US T-Bond

2.32%, -2bp

FTSE 100

,
DAX

,
S&P 500

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Warning signs but more to go?…

Such has been the demand for higher yielding credit risk that the outperformance of this part of the credit market has seen a quite remarkable compression between high yield and investment grade valuations. For instance, the difference between high yield and IG spreads is now at a record tight (157bp) with 15bp of that coming in the last month and 110bp of it this year, as measured by the Markit iBoxx cash index (see chart).

The bigger the risk associated with a structure, the greater the performance of it and therefore the larger the compression.

The AT1/CoCo market has been on fire. Of course, when we get to these levels, some are thinking/expecting a pullback. Fortunately, the excess liquidity in the system will likely prevent that from happening, given that the accommodative policy stance is going to unwind only slowly.

That means it is difficult to envisage when the compression trade runs out of steam. The ‘how’ is easier to answer given that materially higher market rates on the back of a global inflation burst will do the trick. But all the signs are that while we have a sustainable growth trajectory, it comes without any warning signals on the inflation front (say from higher wage growth).

While we grapple with what’s going on, investors flock to higher yielding assets because rate market yields are anchored. Hence, the huge compression we’re seeing between high and low beta risk – and not just in the corporate bond market. Peripheral government markets have found a renewed bid after the Spanish/Catalonia situation comes under some control.

And we construct a positive picture around it because the non-existent default rate, limited leverage increases arising from corporate investment &/or M&A activity and improving credit metrics across the curve – and especially in the financial sector – mean that most corporates are money-good.

So we do have have some reason to believe that we can get more of a compression to occur between high yield and investment grade rated risk. Also that the CoCo market’s spread tightening of 306bp/17% returns this year will likely continue, but also the corporate hybrid market should see more supply as S&P becomes more accommodative in its rating methodology.

Non-financial hybrid index spreads have declined by 145bp this year and the index yield has dropped similarly, to 2.03% – which means to issue now makes sense again (it’s cheap equity after all).


That’s more like it

€600m issued by Whirlpool, just over a year after their previous €500m effort

The primary window was flung open and a welter of deals hit the markets in the session. For investment grade, we had Akzo Nobel take €500m in a 2-year floater format on books 6x oversubscribed while Whirlpool issued €600m in a 10-year at midswaps+40bp (-15bp versus IPT). United Technologies also opted for a 2-year maturity floater format, printing €750m while France’s APRR was in for €700m in long-15-year funding at midswaps+35bp (-20bp versus the initial talk). That was a decent session with €2.55bn issued in it.

In the high yield market, CMA CGM tapped its Jan 2025 issue for an increased €250m, Rexel issued €500m in a 7.5NC3 deal to yield 2.125% and the unrated Eurofins Scientific issued a PNC8 hybrid for an increased €400m, costing 3.25%. The book was up at €3.6bn highlighting the demand for higher yielding risk. It was a very good session in this market, and with €1.15bn issued we’re up at a record €63.5bn for the year to date. Given the pipeline, we wouldn’t be surprised if we actually broke the €70bn barrier this year.

A euro-denominated senior financials deal graced us in the form of a Barclays (Holdco) green bond transaction for €500m in a 6NC5 maturity at midswaps+50bp. And finally, in sterling, HSBC Holdings lifted £1bn in a 9NC8 deal at G+120bp.


Mixed macro, ECB purchases drop

We were greeted with a mixed bag of data in the session, highlighting that whilst we have a recovery that seems to be firming, policy makers will need to be extremely vigilant. German manufacturing recorded a surprise rise in September but service sector activity declined in both Spain and Italy in October. Eurozone producer prices recorded a small rise in September, versus the previous couple of months. UK car registrations declined by 12% in October versus September

Government bonds were better bid in the session across the board. In yield terms, the 10-year Gilt was down at 1.25% (-2bp), the US Treasury at 2.32% (-2bp) and the Bund at 0.34bp (-3bp). The equity markets didn’t show up too much, trading around flat in Europe for most of the session, while we had a tentative opening session in the US on the back of some potential mega M&A (Broadcom/Qualcomm), Trump’s Asia visit and that purge of the ruling elite in Saudi Arabia. Oil prices gained, with Brent touching $64 per barrel while stocks in the US were dipping in and out of record territory – and closing at fresh records, eventually.

The ECB reported that the latest week’s purchases of non-financial corporate debt came in at a reduced €1,047m versus €1,761m in the prior week. The bank’s overall monthly purchases will fall from January (€60bn to €30bn) but there is a good chance that they keep going at €7bn per month of IG corporate debt purchases – at the expense of other programmes. Last week’s lower haul was likely due to a holiday midweek in various jurisdictions.

It is still a decent enough of an effort and should help keep IG continuing to grind tighter as we tantalisingly approach those record lows (as measured by the Markit iBoxx index).

Recent ECB Weekly Purchases

The total purchases to date, after 74 weeks of market participation and intervention, stand at €122,265m with the long-term weekly average purchases to €1,652m. The ECB owns 17% of the eligible market (of around €700bn).

In credit, the iTraxx indices were barely changed in the session leaving Main at 49.4bp and X-Over at 223.5bp, reflecting the uncertain session in stock markets. In the cash corporate bond market, we closed unchanged in investment grade with the index at B+95.5bp and the same with high yield, the index at B+254.8bp.

Have a good day.


For the latest on corporate bonds from financial news sources, click here.

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.