3rd February 2020

🇨🇳 How the Chinese Slump will Impact Credit

MARKET CLOSE:
iTraxx Main

45.7bp, -0.7bp

iTraxx X-Over

227.0bp, -4.3bp

🇩🇪 10 Yr Bund

-0.44%, unchanged

iBoxx Corp IG

B+105bp, unchanged

iBoxx Corp HY

B+361bp, -6bp

🇺🇸 10 Yr US T-Bond

1.52%, unchanged

🇬🇧 FTSE 100 5884.65, (-0.59%) 🇩🇪 DAX 12854.66, (-0.42%) 🇺🇸 S&P 500 3426.92, (-0.40%)

Global slowdown to add to woes…

Shut down the world’s biggest factory and all that goes with it (supply lines/travel etc) – and as well as it being the second-largest consumer market, then it naturally flows that there is an obvious hit to global growth.

Shut it down for an extended period of time and policy markers start to get twitchy; Extremely so. Already struggling to officially make 6% for 2020, after recording its lowest annual growth level in 2019 (6.1%), we’re looking at Chinese growth this year coming quite likely with a 4%-handle.

China accounts for over 15% of global growth. Global growth was forecast to come in at 3.4% this year (IMF numbers). The odds are, though, that getting a grip on the spread of the virus is going to become a marathon and high levels of vigilance will remain for months to come. And so the coronavirus’ impact must surely lead the IMF’s next forecast to be lowered again by a few tenths, and maybe (eventually) to below 3%.

The Eurozone’s growth dynamic is going to be similarly impacted where pre-coronavirus projections were in the range of 1% – 1.2%. We must be looking at recessions being called across some of the region’s economies come the end of Q2, if not before.

The US will slow, but Trump’s focus on becoming more ‘domestic focussed’ – America first and all that – might just see her avoid some of the ravages that will beset other economies around the world.

However, there will be an impact as reduced tourism, their spending and international trade along with other macro dynamics are felt. The initial forecasts are pitched at US GDP losing 0.2% in the first quarter, that’s relatively small change.

We opened the week on news that Chinese stocks had fallen by up to 9%, after markets reopened following the lunar new year. That was the catch-up trade. European markets shrugged off the declines with a tentative trading session in the black, registering limited gains.

However, the weakness will be back as the coronavirus’ spread escalates, and leaving the knock-on impact on global activity to persist through February (at least), we think.

The weaker domestic currency, effect on corporate cash flows and liquidity, and then debt servicing of highly indebted Asian (predominately Chinese) corporates is also going to filter through into a higher debt default rate.

That secondary dynamic will eventually weigh on other debt markets as well. In tomorrow’s note, I’ll address the impact the current dynamics are having on European credit


China pummelled, other markets steady

So, it was a mixed session led by the huge drop in Chinese stock markets overnight. There was little in terms of a spillover.

Good news saw UK manufacturing stabilise in January with the PMI index rising to a 9-month high of 50 (from 47.5 in December). It’s a weak rebound, but a rebound nevertheless. The argument will be around whether that rise is sustainable.

The coronavirus outbreak, as well as the slowdown anyway in external markets, might easily proffer an answer to that.

Brexit was also back in the news as investor nervousness rose on the back of the narrative of the negotiating tactics. Johnson and Barnier set out their respective negotiating stalls for the 11 months ahead, exposing a deep rift and a gulf between their expectations which seemed as large as ever.

The initial skirmishes promoted fears (again) of a hard Brexit at the end of the year. They saw to it that sterling weakened by 1% or more versus the dollar and euro, but that gave a bit of a push to the FTSE which eventually rose by 0.6%. The Dax was up by 0.5% and both markets benefited from the strong open in the US where gains of 1% or higher were recorded, as at the time of writing.

Rates didn’t do too much. Yields managed to edge a little higher for much the session the session as confidence returned in the session in riskier assets. However, a bid re-emerged towards the European close. The 10-year yield on the US Treasury was unchanged at 1.52% at the European close, where the Bund yield on the same maturity also closed unchanged at -0.44% as did the Gilt yield, left at 0.53%.


Credit markets muddle through

Elsewhere, there were deals in credit, but the corporate ones which mattered were in sterling. Volkswagen Financial Services printed £400m in a 4-year at G+130bp, while United Utilities printed £250m in an 18-year priced at G+87bp. There was nothing in euros, anywhere.

Finally, we had Poland join the sovereign group of issuers busy in the markets this year. They took €1.5bn in a 5-year priced at midswaps+19bp, with interest for the offering coming in at around €6bn and final pricing 6bp inside the initial indication.

The ECB added an increased €1,613m of new corporate debt last week (versus €435m the week prior), taking their total haul now to €189,117m. The €1.6bn hoovering last week is the largest weekly addition since QE restarted three months ago.

The improved tone helped push protection costs lower, and thus the iTraxx indices edged tighter. So Main closed at 45.7bp (-0.7bp) and X-Over was 4.3bp lower at 227bp.

In cash, there wasn’t much going on and especially so given that the primary market drew a blank. So the iBoxx index for IG corporates closed unchanged at B+105bp, but we did see some moderate levels of weakness in the AT1 market with spreads on the index at B+386bp at the close (+10bp). That was likely due to month end index changes because it wasn’t evident during the session.

The IG sterling market was also unchanged, the index at G+133.4bp. Finally, the high yield market moved a touch better but that was more likely also due to month-end index changes, the index left at B+361bp (-6bp).

Have a good day.

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.