14th June 2016

Yesterday, all my troubles…

MARKET CLOSE:
FTSE 100
6,045, -71
DAX
9,657, -177
S&P 500
2,079, -17
iTraxx Main
82bp, +4bp
iTraxx X-Over Index
349bp, +15bp
10 Yr Bund
0.02%, unch
iBoxx Corp IG
B+144.6bp, +1bp 
iBoxx Corp HY Index
B+490bp, +14bp
10 Yr US T-Bond
1.61%, -3bp

If we are turning Japanese, or Swiss…

The pre-occupation with the 10-year Bund yield going to zero and into negative territory is so yesterday! We should be looking at the measly 22bp offered by the German government’s 15-year obligation. japanese swiss rollAfter all, if we go Japanese (or rather Swissi) we get through zero and then negative yields on the 10-year Bund – and beyond into longer maturities. It also means that all the warnings of a potentially sharp reversal in asset prices (and yields) are unfounded. The cautious tone and musings exhibited by some market participants – us included – will be seen to be useful only in terms of offering some perspective, but that’s about all. We are all long this trade.

It will also mean the global economy is truly a busted flush and we’re merely going to be ticking over for the next few years. There will likely be further easing to go, with already low yields, more warnings from central bankers as they cut rates and other asset bubbles possibly emerging, but then an almighty thud – one day. That day of reckoning could be a while yet. After all, Japan has had many a false dawn over the past 25 years, the USA seems to be entering the same kind of dynamic and China isn’t far behind, while the eurozone is doing its best to just stabilise at a low level. Growth and inflation continue to elude us, rich assets (bonds) can get richer and the continuing despair and desperation see us sucked into some kind of vortex of panic buying, happy to preserve capital.

Statistics highlight the frustrations to come

The ECB released details of its purchases last week. Although only the first day’s grabfest was published, the €348m of purchases is a massive number. Annualised, that makes €87bn, or €7bn a month. That is a huge amount in anyone’s book, but we would be surprised if it keeps that pace going. There would be serious consequences for the corporate bond market if it did – and not just reflected in sharply lower yields and tighter spreads (see later). Secondary market liquidity would be a “concept” of the past (as the Street asks where the ECB’s bid is), and we would likely see completely unrealistic HY bond market valuations as investors piled into this asset class. We would think that the ECB has likely picked much of the low-hanging fruit as dealers would have been positioned for them to come in. It might be a different story once those inventories being to decline.

In addition, the release of the Bunge deal statistics showed that the ECB (“official institutions” in the stats) allegedly took 15% of the deal. That’s €90m of a €600m transaction, where the book size was €2.8bn or 4.7x covered. So it is a high allocation, in our view. Bunge wasn’t the “greatest” of names, but that was a good order book, albeit likely skewed higher by a €420m possible order from the ECB (if it put in for its 70%). In theory, if it had put in for €420m (the maximum allowed), it received 21% of its order. This might set a pattern for future participations, in that it might automatically put in for 70% of every deal it participates in and hope that 15% or more is its final allocation. That is going to leave quite possibly 15% less of every deal to go round and if so, investors are going to feel the squeeze of the ECB’s tentacles almost immediately.

Bank syndicates do not usually pro-rata orders but give a higher percentage to real money investors rather than banks, hedge funds and private banks. We would question why they felt the need to give so much (allocation) to the ECB – if indeed they did?

Corporate bond yields heading for record lows

The largest fixed income assets of them all, government bonds, are already displaying the results of economic crises as their twin safe-haven and capital preservation appeals push them to unprecedented levels (price and yield). Next up though is the corporate bond market. Despite spreads grinding out broad performance (on the ECB’s participation) and the front end shifting ever further into negative yield territory, we still have a way to go before we see the lows in yield and spreads across the broadest sections of the market. Looking at it from an index perspective, the Markit iBoxx IG corporate bond index has yielded 1.02% at its record low and B+94bp for the corresponding low in the spread (see chart). Given how things are playing out, we look for that to be tested over the next few months, with the compression between high and low beta to accompany it.

Corporate bond yields/spreads to test lows

 

Record Lows

Blaming it on the Brexit

If not on the growing belief that a UK exit from the EU is coming, then we can believe that macro weakness is responsible for the current ills impacting risk assets. Weakish Chinese data overnight set the tone for the session, as we had a 3%+ drop in stocks Asia to wake up to. The DAX took another tumble and most other bourses followed, but the Bund failed to rally and get that 10-year yield over that landmark 0% line. The 10-year Gilt yield nevertheless reached an intraday record low of 1.20%, with some suggesting another round of BoE QE to come should the Leave camp succeed next week. Gilt yields would fall in the event, supported by a flight-to-quality trade as the institutions piled in, so further QE (bond purchases) would be deemed unnecessary in our view – although if it were, we would be looking at a rate cut, if only to erase lingering event risk fears. That is, we would expect the markets would for once do much of the heavy lifting for the central bank.

Bund yields closed unchanged at 0.02% for the 10-year while the equivalent Gilt closed at around its own record low of 1.21%. Oil was barely holding $50 per barrel (Brent). Equities took a severe downleg with the DAX off 1.8% at 9,657 (-177 points) and all other bourses were off by a similar amount, if not more. The FTSE lost just 1.2% while US stocks were in the red too.

In credit, primary was again very quiet with Southern Power the only borrower in the non-financial corporate bond market with a €1.1bn 2-tranche green bond, pricing 10-15bp inside initial guidance. In secondary, we edged a little weaker amid little activity with the Markit iBoxx index for IG up at B+144.6bp with the HY market exhibiting more weakness, the iBoxx index left at B+490bp (+14bp). The iTraxx indices moved materially wider, with Main up at 82bp (+4bp) and X-Over at 349bp (+15bp). Given how the US closed overnight with the S&P off 0.8%, we could be looking at a weak opening today

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.