4th January 2017

What goes up must…

MARKET CLOSE:
FTSE 100
7,178, +35
DAX
11,584, -14
S&P 500
2,258, +19
iTraxx Main
69bp, -3bp
iTraxx X-Over Index
280bp, -8bp
10 Yr Bund
0.27%, +9bp
iBoxx Corp IG
B+135bp, -1.5bp 
iBoxx Corp HY Index
B+400bp, -11bp
10 Yr US T-Bond
2.45%, +1bp

Unleashing the beast…

RCI Banque chimed in with a new year deal

We’re off and running, and as we might have expected SSA/covered bond issuance dominated the early primary market skirmishes – although there might have been surprise in some quarters that RCI Banque sneaked in a deal, as did BNP in senior non-preferred format. Inflation data for the Eurozone was the first piece of macro data this year and it was surprisingly upbeat.

In fact, all the day’s data was upbeat and should it come to fruition that we are in the throes of an economic uplift which might be sustainable then it makes a mockery of our own comment from yesterday suggesting that the fixed income markets still have some life in them yet. Because they won’t.

German inflation kicked us off, the French inflation data was also good while the Eurozone’s data comes later this week. For Germany, the December inflation rate was up at a stunning 1.7% (versus 1.3% expectations)! German unemployment remained at record low levels.

In the UK, manufacturing activity hit a two and half year high in December. US manufacturing activity for December grew at its fastest pace for two years. Even oil prices were rising, with Brent trading off a $58 handle – before they succumbed as the session progressed to record a small decline. It’s all a far cry from how we traded in the opening couple of months of 2016. The ECB will be watching very closely and we might expect some sort of adjustment to policy come June (that is, less accommodation).

With all that, equities generally rose (even as a Trump tweet tried its best to derail them as he threatened import taxes on GM cars made in Mexico/abroad), government bond markets came under pressure (on that improving macro data) while the corporate bond arena did little flow-wise, but spreads did tighten with higher beta risk outperforming. Still, we clipped some negative returns for investors as the underlying yield rose on the opening day of the year. There’s already much food for thought for investors.

Recap on expectations

As laid out in yesterday’s opening comment for 2017, we are looking for a moderate tightening in spreads from B+135bp to B+120bp, as measured by the cash Markit iBoxx corporate IG bond index. We look for 33bp of tightening in the HY index from around B+413bp to B+380bp. If the current economic optimism becomes a reality, the synthetic corporate markets will outperform and protection costs will fall considerably.

We would be looking for X-Over to significantly outperform Main and move from 288bp to the low 200bp area, with Main to drop into the low 60bp level. Already, they trade on a X-Over/main ratio of 4x but that could head towards 3.5x or lower as the year progresses.

Cash returns in IG are currently pitched at 2% for the full-year while HY markets could deliver 5%, in our forecasts. Those returns will depend much on developments in the underlying and corporate bond total return based investors will be hoping that yields don’t fall out of bed.

Economic growth on any rapid-like trajectory is going to be the death of the corporate bond market. Only from a valuation perspective. Higher government bond yields on anticipating higher inflation and eventually higher policy rates and less QE will see cash scurry from bonds to equities. That rotation (and/or risk of it) will impact those expectations above. Admittedly, right now we are in that early new year period where participants are upbeat – for all asset classes. Corporate bond – and other fixed income investors – probably just need to be a little more wary than they usually are.

On the primary front, we think that the markets could be closed for lengthy periods. Trump’s inauguration will send some jitters through markets, the French elections threaten the same in Q2 while we have German elections due in September. Within that, we have the prospect of a new government being needed soon in Italy, that country’s banking sector is back in the spotlight while Article 50 in the UK is due to be triggered by the end of March. That is a high level of potential event risk. We think that IG non-financial issuance of €250bn (€273bn in 2016), HY supply of €40bn (€47bn) and senior debt prints of €140bn (€145bn) would be a good effort this year.

The Italian bank is marketing a new deal

We got off to a very good start in yesterday’s session with RCI Banque printing €750m at midswaps+70bp – and some 15bp inside initial guidance leaving the market to push on from where it left last year in terms of pricing dynamics.

BNP printed €1bn at midswaps+92bp, again some 13bp inside the initial guidance as it issued in the senior non-preferred format. To cap it off for the banking sector, Intesa SanPaolo was marketing a CoCo/AT1 deal.

Day 1 proper and it’s risk-on

The opening session proper of 2017 was a fruitful one for risk assets. The DAX index was alone in being in the red for the session with all other equity bourses showing up in the black. Government bond markets were in reverse and the rise in yields was quite spectacular. The 10-year Bund yield closed at 0.27%, or 9bp higher in the day – as did the equivalent Gilt yield, to 1.33%. Portuguese 10-year yields rose 18bp to 3.90%, we had +12bp on BTPs (1.86%) and 8bp of weakness for Bonos (1.41%).

In cash credit, the market moved 1.5bp better as measured by the Markit iBoxx cash index for IG, left at B+135bp while the index yield rose 5bp to 1.21%. The high yield market was going great guns, leaving the index at B+400bp (-11bp) with the yield on the index falling 7bp (shorter duration product) to 3.67% (-6bp).

The sterling market painted a similar picture, with spreads on the Markit index seeing 150.5bp (-1.5bp) although the Gilt market sell-off saw the index yield rise 8bp to 3.02%.

Into the better economic data flow, the iTraxx indices moved lower – sharply. Main outperformed and was down at 69bp (-3bp) and X-Over at 280bp (-8bp) as the cost to insure credit risk fell.

We will be back Friday morning, as the site will be undergoing server maintenance on Thursday. Have a good day.

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.