- by Suki Mann
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|10 Yr US T-Bond
|FTSE 100 ,||DAX ,||S&P 500 ,|
Good riddance and all that…
Yuck! Good riddance to the first quarter. It’s been a difficult one for all, and while government bond markets have come out tops, it has likely only delayed their day of reckoning in deferring the prospect of higher market rates (weaker performance) into later this year. That’s assuming the more patchy macro recovery seen in Q1 is not anything more sinister and is just a blip in the bigger picture.
Mind, if we are looking at having had the best of the economic recovery or close to it, then fixed income will continue to perform. Much of the macro dynamic will depend on how any event-risk, or episodes of them, play out. In that sense, Q2 promises as much uncertainty as the first quarter.
US President Trump is the fulcrum of much of the uncertainty. But there are more than a few indicators suggesting that the wheels on the macro-bus are feeling a little buckled. The data of late hasn’t been overwhelmingly positive unlike through an upbeat Q4. Some of the caution (weaker surveys etc) might be due to a more defensive moment given the prevailing uncertainties, the principal culprit of that being the trade tariff regime to come.
The key takeaway for the opening period of 2018 is that ‘trading Trump’ is anything but easy. Having potentially made some serious and significant progress on the North Korea front, he stirred the markets with his trade protectionist policies – or a need to realign them, and he is now going after online retail giant Amazon. As far as the US President is concerned, he is defending the ‘little guy’ who coincidentally put him into power, and making good on his promises as the mid-term elections approach – whatever the consequences might be for the markets. While there is a sense of method in his madness, there’s volatility in markets as they try to deal with the chaos generated by it.
Safe-haven lure boosts fixed income
Performance saw further weakness through March for equities especially, the Dax eventually down by 6.4% (total returns) in the quarter, the FTSE off by 8.2% and the Dow Jones index -2.5% for the opening three months of the year. And that, after a monster rally in the month’s final session. Even while equities rallied in that final session, safe-havens held firm (as opposed to selling off) likely because equity investors were squaring up positions and probably buying stocks that were deemed to be cheap.
YTD Returns to end March 2018
Fixed income overall though had a better time of it in March, with the duration rally rescuing lots of the performance lost during the opening couple of months.
For the quarter, euro IG and HY credit (Markit iBoxx) is down around 0.5% on average – representing a slight deterioration through March to add to the losses recorded in January and February. Eurozone sovereigns though have been the turnaround kings, returning +1.3% – having been down 0.3% in the opening two months. The rally in Gilts has helped the returns for sterling corporates improve a little too, a loss of 1.7% in the opening two months becoming -1.5% for the quarter.
What for primary?
The surprising aspect in credit during the first quarter was the lack of deals in IG non-financials, while the high yield market and the senior financial issuance levels were at elevated levels – piping up with a little over €19bn and €50bn, respectively.
The €55bn of IG issuance is the lowest for any opening quarter since at least 2012, and we don’t even have a financial crisis to blame for the lack of deals. Were it not for the timing of the Sanofi and Richemont deals, where the borrowers printed almost €12bn between them on successive days, then we would have been looking at a quite alarmingly low level of debt.
That would have had alarm bells ringing for borrowers, hitherto used to Q1 being the heaviest of quarters into a usually upbeat tone, with oodles of sidelined, fresh and redemption cash looking to get invested.
Not this time. Nor is it the case that the lack of supply has seen solid support for spreads. Spreads have gapped wider after hitting record tights in most markets at the end of January/early February. Admittedly, equity volatility has been at elevated levels and higher than we might have liked, but there’s little in the story (macro, geopolitical etc) to suggest that we ought to have fallen out of love with the asset class.
Nevertheless, that the iBoxx IG spread index is 10bp wider in the opening quarter is difficult enough to explain. After all, the ECB is taking down an average of €1.6bn of IG debt per week (mostly in secondary) and that in itself should help support the €700bn or so of the eligible market (the central bank holds €150bn of corporate bonds).
So it’s been a difficult month for spread product, with the IG index 16bp wider in March, the high yield index some 26bp wider and the CoCo index giving up 45bp. Non-Financial corporate hybrids widened by 24bp while the sterling corporate bond index only widened by 12bp.
Fundamentals remain broadly supportive, too, even if some of the recent macro data points leave us thinking that the growth trajectory is showing signs of moderating. Technicals, as already suggested in terms of supply/demand, are supportive while rate markets rallying can only help improve the lure of corporate bonds as a fixed income asset class offering a little bit more juice versus government bonds.
Q2 primary to toil
For the second quarter, we are thinking in the context of €60bn+ of IG non-financial issuance but would not be surprised if we got a significantly higher level than that which could materialise IF borrowers have been delaying their funding plans because of the volatility we experienced in Q1. They either bite the bullet and print because there is no guarantee that markets will be less volatile going forward – unless plans were already afoot to print in Q2. If we see only in the €60bn area for the quarter as a whole, then we’re going to be looking at barely €220bn for the full year – which would be extremely low for a market used to averaging €255bn (last 5 years).
As for this week, we are back in action following the long weekend with Eurozone/UK manufacturing PMIs for March due, the publication of the US red book as well as US car sales for March. Wednesday sees core Eurozone CPI and the US ADP employment report along with durable goods orders, non-manufacturing and services ISMs. Eurozone retail sales and PPI come through on Thursday before we close out the week with the US non-farm report (consensus 198k).
The market was open on Monday in the US. And it was a weak start to the month for equities as they dropped by well-over 2.5%. Amazon and its stock price felt the ire of another Trump Tweet, Tesla dropped hard on the back of a recent driverless car fatality as well as that credit rating downgrade, and we had Asian manufacturing data signalling some recent weakness. There was also that imposition of trade tariffs on 128 different US foodstuffs by the Chinese authorities. Macro is in for a more uncertain trajectory. Here we go again….
Have a good day.
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