28th September 2016

Unleashing a spiral of contagion

MARKET CLOSE:
FTSE 100
6.808, -10
DAX
10,361, -9
S&P 500
2,160, +13
iTraxx Main
74bp, +1bp
iTraxx X-Over Index
338bp, +5bp
10 Yr Bund
-0.14%, -2bp
iBoxx Corp IG
B+126.7bp, +1.7bp 
iBoxx Corp HY Index
B+448bp, +7bp
10 Yr US T-Bond
1.56%, -2.5bp

It isn’t going to happen…

Dark times for Deutsche Bank but not the end

Dark times for the German giant, but not the end of the road.

There is rarely any smoke without fire, but we don’t believe the demise of Deutsche Bank is imminent. They might need more capital – lots of it, but they’re big enough and tough enough to handle it. Should “it” go awry, then that institution’s collapse – or otherwise – would unleash an unprecedented spiral of contagion through risk assets which would see previous crises pale into insignificance. There is much political posturing at the moment – with politicians needing to be seen to be talking tough for whatever reason – but when push comes to shove, we know which side their bread is buttered on.

A world already besieged by low growth, consumption and inflation and a massive debt burden everywhere would not be able to control a major banking collapse. That’s why Deutsche will come through this period of uncertainty in some form or another – and the global financial system will live to fight another year.

That said, something’s potentially amiss with Germany Inc. Yesterday, NordLB followed in the footsteps of Deutsche Lufthansa in pulling a deal. They might have cited adverse market conditions, but there is always (well, usually) a price. EnBW, on Monday, after all managed to get a hybrid deal away in the dollar market without too much fuss. In addition, “market conditions” saw to it that Korean Air Lines pulled a potential – and testy, 30NC3 dollar offering to bring the tally of cancelled deals to three in two days. Mind – and probably on that NordLB news – Deutsche Bank stock endured a choppy session with banking stocks generally feeling the pinch.

Vodafone_logoThere was some normality though in primary as Vodafone opened the account this week for non-financial IG corporates as the telecom giant issued a €750m deal, in a long 7-year offering and managed to price it 15bp inside the initial price talk. Phew! Babcock International visited the sterling market for £250m on a day when the BoE started its first QE-related corporate bond operation as it seeks to load up on £10bn of corporate bond debt over the next 18 months.

Yields heading to our target level

With some suspicion as to what might be erupting in Germany, there was again a safe haven bid which left government bonds again in the ascendancy. The Bund yield (10-year) is now at -0.14% (-2bp in the session, did visit -0.15%) and is heading to -0.20%, which is our target level for 2016 – but for different reasons! The United Kingdom also benefited with the equivalent Gilt yield back below 0.70% at 0.67% (-2.5bp). The potential contagion from banking sector weakness left BTPs under some pressure and 10-year yields at 1.21% (+2.5bp), although Bonos closed at a record equalling historic low of 0.89% (-2bp).

Equities had another session in the red, down around 0.5% for the major bourses while oil prices fell on yet another failure on agreement in OPEC on controlling output (Brent trading off a $45 per barrel handle, over 3% lower). Otherwise, news flow was light save for some better US service sector, consumer confidence (at a multi-year high – must be something to with Trump?) and house price data.

Riskier markets helping credit total returns

The better bid for government bonds, which is driving yields lower – and spreads only just marginally wider, are going to make returns look super good at the end of the third quarter. We have just three trading sessions to go! To start with, the S&P closed firmly in the black overnight, so we might get a head start from that in today’s session.

IG spreads moved wider overall, the Markit iBoxx index to B+126.7bp (+1.7bp) but returns are now up at 6% YTD. The HY market took a little bit more pain though with spreads on an index basis 7bp wider at B+448bp (seen back in early August) and returns down a little. We’re about 50bp off the lows seen this year. And finally, the iTraxx indices closed with Main up at 74bp (+1bp) and X-Over at 338bp (+5bp).

Let’s hope for better pickings today. Back tomorrow morning.

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.