13th February 2018

Credit finally under some pressure

MARKET CLOSE:
iTraxx Main

56.8bp, +2.8bp

iTraxx X-Over

281.9bp, +12.6bp

10 Yr Bund

0.75%, -1bp

iBoxx Corp IG

B+88.6bp, +2bp

iBoxx Corp HY

B+307.8bp, +10bp

10 Yr US T-Bond

2.85%, unchanged

FTSE 100 , DAX , S&P 500 ,

But still has its fan base

The corporate bond market seems like it is coming under some pressure. Primary isn’t firing on all cylinders and secondary is just beginning to feel a little of the chill. The tone is much improved elsewhere though, even if markets are not necessarily flying. So, into that risk-on like environment, what level of risk dare we put on?

In Monday’s comment we discussed briefly the compression trade – or rather the decompression we’ve observed between high and low beta credit of late. And we surmised that it was driven by the sharp sell-off in equities having a greater impact on marks in the high yield market, given that movements in the two markets are extremely well correlated.

In addition, we suggested that it had nothing to do with the reduced level of crowding out of investors as a result of the lower uptake of IG debt by the ECB where the overall asset purchase programme is reduced from €60bn to €30bn per month and the monthly corporate debt haul is reduced from ca. €7 – 8bn to ca. €5 – 6bn.

IG spreads have stayed much firmer than we might have expected in the recent sell-off. A drop in equities like we have been through would necessarily normally have elicited a much bigger weakness in IG. The iBoxx index, used as a broad measure for the cash market, has moved only 6.6bp wider (from a record low of B+82bp to B+88.6bp) but will soon be back on a tightening trend.

We would argue that the high yield market has also behaved in a measured fashion with little sign of any panic while stocks were dropping like a stone (index from B+265bp to B+307bp). That might seem big (+15%), but this illiquid secondary market is always prone to exaggerated moves should equities dither.

We happen to think that spread recovery will be laboured, though, just because too many believe the corporate HY market is too rich now, but investors will be – and are – willing to add in primary where prices can be dictated better.

Keeping the bid for euro-denominated credit intact is the economy recovery dynamic which will serve to underpin corporate credit fundamentals. And while rates are moving higher, we might just have had the big moves (10-year Bund yield up around 30bp this year). That means, as we still view the corporate bond market as some sort of safe-haven fixed income asset class, it still offers a decent pick-up (or somewhere to park cash) versus government bonds. It’s not exciting, but we can live with it.

So any further mini sell-offs, along with any collateral turbulence, is likely going to be equity-focussed and might drag in rate markets. Any subsequent weakness in credit is an opportunity (of course, liquidity permitting) and we would look to add in the CoCo market should the opportunity present itself. This market has legs in it, and while we saw some decompression between it and IG, the compression can be just as rapid.


Rangebound markets finding their feet still

By all accounts, it looks as if UK inflation might have peaked. Although the rate came in unchanged at 3%, versus expectations of a drop to 2.9%, most are of the view that slowing factory and food price inflation will start to see the rate drop. Gilts ended unchanged on the news at 1.60% only to edge higher later (1.62%, +2bp) while the initial sell off in equities was reversed to leave them a small up. Wednesday’s US inflation report might stir the pot a little more.

Away from that, PepsiCo‘s results beat expectations and the news flow otherwise was extremely light. US stocks opened in the red, but the weakness was very limited given some of the recent moves. So we traded in rangebound fashion for the equity markets – but in the red, the Dax off by over 0.7%, the FTSE flattish and US stocks spinning in and out of the red/black.

Rates were mostly better bid, but even here it was all about playing out in a tight range. US Treasury yields in the 10-year were unchanged at 2.85% while the equivalent Bund yield edged lower to 0.75%.


Where have all the borrowers gone?

In credit, primary was as dull as could be. We did, however, contend with one corporate non-SSA deal as Finnish insurance giant Sampo Oyj lifted €500m in a 10-year at midswaps+58bp which was 12bp inside the initial guidance. And Madrid issued €1bn in sustainable bonds also in a 10 year maturity. There were several new mandates announced, and with the pipelines building, we’re looking at a potentially busier March period given the lack of issuance so far this year.

So, for the opening six weeks of the year, we have had €26.9bn issued in IG non-financial corporate bonds, of which €8.7bn has been printed this month – and nothing this week as yet. The high yield market has furnished us with €6.7bn of issuance, with €1.7bn of that this month – and again, we’ve drawn a blank here too this week.

Senior financials had their usual sprightly start with January seeing €21bn of supply, followed by just that €1bn Nordea issue last week since then.

All of this is just scraps. While we do think that the rest of the month will see a pick up in issuance as market tensions ease (hopefully they do), March could be a blockbuster month. The European earnings season will also largely be behind us. We have had past March months where issuance in IG non-financials has topped €40bn with 2015 and 2016 being the previous occasions, while €30bn+ is a ‘gimme’.

For Tuesday’s session, the iTraxx markets threw in the towel and were wider throughout the day. The moves were big. We closed with iTraxx Main some 2.8bp higher at 56.8bp and X-Over rose 12.6bp to 281.9bp – the highest levels for the S28 contract.

In cash, we also had weakness in the session with the iBoxx index 2bp higher at B+88.6bp, the Beni Stabili deal from Monday wider than reoffer – it was priced 12bp tighter than IPT, and off a low €400m book for a €300m deal. And the CoCo index moved 16bp wider, erasing almost all of this year’s gains, now at B+358bp!

Finally, the high yield also felt bit of a cold chill, the Market iBoxx index marked as wide as B+307.8bp (+10bp) – and the widest level since June last year!

Have a good day.


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

Suki Mann

A 30+ 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 CreditMarketDaily.com.