Tag Archives: Weekly Credit Wrap

When Doves Cry

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Credit is a funny asset class. It is part risk-on, part risk-off, and sentiment in and around the sector reflects its Jekyl and Hyde nature. This past week was a case in point. We’ve had dovish comments recently out of both Yellen and Draghi, both suggesting that current economic activity allowed for plenty of flexibility on monetary policy. The prospect of continued or even further stimulus gave risk assets a bit of a boost, and credit spreads did well for a few days. Not coincidentally, it was the same period in which equities did well.

Then the market saw a couple of days of bad news – mixed signals from the economy, and weak earnings out of Wal-Mart sent stocks lower, and credit followed suit. 10 year bank credits are usually the most visible in the cash markets, and they widened by about 5 basis points.

As a result, credit markets were very receptive to new issue in the early part of the week, but supply tapered off as spreads moved wider. $40 billion in investment grade corporates came to market, and follow-on secondary trading activity has been mixed. Most new issues look like they’re trading wider, some are trading tighter. Pfizer was among the biggest issuers, bringing $4.5 billion across five tranches, and Volkswagen did $3.5 billion. Pfizer bonds are lagging since their deal priced on Monday, with spreads wider by 3-5 basis points. The Volkswagen deal priced amid some spread weakness on Thursday, which perhaps explains why their bonds are trading 3-5 tighter.

At the same time, interest rate levels dropped to the low end of their range – 10 year rates dipped below 2.5%. Bottom line, even though credit felt squishy going into the end of the week, the average spread month to date has barely changed, and prices of investment grade bonds have moved higher. As one trader commented, in spite of the spread weakness, the market still feels constructive.

Or maybe the market just doesn’t know what else to do. It is totally hooked on central bank stimulus. Maybe I’m just 2 demanding, but it’s hard to see valuations surviving a hawkish attack.

Nuthin But a “B” Thang

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It was just last week that Apple came to market with a $12 billion bond deal, presumably to fund its share repurchase program. The market (as readers may recall) breathed a sigh of relief that the deal was significantly smaller than the $20+ billion that had been speculated.

And now, just a few days later, Apple is again in the news, this time on speculation that it will be paying $3.2 billion for Beats Electronics LLC, the maker of expensive, hip headphones and sponsor of a new streaming music station. We will leave it to the equity analysts to decipher whether this is a good deal for shareholders. We are trying to sort out whether it means anything for bondholders. The short is answer is: probably not. For a company with $150 billion in cash, a $3 billion deal is simply not large enough or transformative enough for it to have any impact whatsoever on credit quality. Credit spreads haven’t budged (one way or another) on the news. Even the 10 year from last week, which we noted was the weakest performer, is trading about 2 basis points tighter than new issue.

The potential transaction does underscore the danger of owning bonds of high quality issuers. There is an enormous range of potential outcomes, a whole host of nasty things that Companies can do with their cash. So which poison would we pick? Acquisitions are generally scarier – they can dramatically and suddenly alter a company’s risk profile. But share buybacks can result in death by a thousand cuts. As we move through the credit cycle, anemic growth and deteriorating margins tends to drive managers increasingly into the realm of financial engineering. Credit risk’s single tail becomes ever longer.

But for the past week, there was little sign of heightened risk. Or return, for that matter. Corporate bonds generated total returns for the weak of -0.06%, and excess returns were about the same. The new issue calendar was very average – about $22 billion of deals, and no big blockbusters this week. JP Morgan brought $2 billion of a new 10 year bond, which priced at +100, and did not really perform. Caterpillar Inc. came with $2 billion, with 10 year, 30 year, and a 50 year. The 50 year is not a typical maturity, and we think the pricing was very attractive – bonds traded 11 basis points tighter in the secondary. Next week looks like it will be more of the same – spreads continuing at tight levels, an average calendar of $20 billion….

….and the beat goes on…..

Sideways

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The yield curve is flattening in a big way. The spread between the 5 and 30 year treasury bonds is 168 basis points, compared to 250 last November. We have been expecting a flatter yield curve –it is an important sign of normalization. But investors seem to have been caught off guard by the strength of long term bonds. Treasuries with maturities of 20+ years have been among the best performers in the market, generating over 11% returns year-to-date. Not too shabby, especially given that rates are supposed to be moving higher.

Of course, rates will be moving higher – the Federal Reserve has made that perfectly clear. But not quite yet, and they’re only talking about short term rates. So the curve that is taking shape is significantly flatter, and at least right now it looks like higher rates will mostly be felt inside of 5 years. The long end tells a very different story, and for Credit, the story unfolding suggests a pretty benign, if uninspiring outlook. Looking back to the last credit cycle, when the curve finally started to flatten, credit spreads largely moved sideways for several years, in a range of about 10 basis points.

Looking at the past week, spreads were a little tighter, and for the month of April, generated positive excess returns of 41 basis points. The long end outperformed strongly, with total return for the month of 2.24%, and 62 basis points of excess return. Supply for the week came in at $32 billion, driven by the Apple deal. The market had been anticipating this deal following Apple’s announcement on April 23rd that it would be issuing bonds to fund share buybacks, but the deal was much smaller than expected – just $12 billion instead of $20 or more. The deal was well received (with the exception of the 10 year – the only tranche that moved wider on the break) and spreads for existing Apple bonds tightened.

The market as a whole right now has a complacency that leaves us wondering what else is going on out there. It feels a lot like middle age – reviewing where we’ve been, wondering if we’ve done enough, and when it all falls apart. The signs of middle age for the market are definitely there – a flatter yield curve, modest movement in credit spreads, modest economic growth. Now I guess we’re just waiting for someone, somewhere in the market to push things a little too far. It always seems to happen in middle age. The risk is greatest when we are no longer content with moving sideways.

To Buy or Not To Buy

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Investment Grade new issue was dominated by bank and finance this week. The primary market saw $26.5 billion in supply, over 50% of which came from financial issuers – and within that, 5 year bank paper was the most popular. USBank, Capital One, Fifth Third Bank, and Suntrust all came to market with 5 year bonds post-earnings. That seemed to put a bit of pressure on financial spreads. Overall, spreads were relatively unchanged all week, but bank names were a touch weaker as accounts were trading positions to make room for supply.

Away from 5 year space, Morgan Stanley had one of the week’s larger transactions, with a $3 billion new issue 10 year bond. It priced at +130, and seemed to be well received, but is now trading a few basis points wide vs new issue levels. Spreads in general gave up some ground on Friday in the face of Russia/Ukraine, heavy supply, and what feels like a real lack of conviction about market direction.

And this brings us to the crux of the matter. Investment Grade credit spreads are trading at their post-crisis tights – still a bit wide compared to pre-crisis levels, but for some very good reasons. We find it hard to support a significant move tighter. On the other hand, spreads remain well-supported by fundamentals, and market appetite has been insatiable. The economy is in solid shape, interest rates are under control, and volatility is low. This period of tight spreads could easily carry on for many months. Going short credit seems like a suicide trade. But it is the dread of something after the spread tightening comes to an end that causes us to raise the question.

Greece is the Word

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Yesterday Greece was a rock star, returning to public debt markets with a € 3 billion 5 year note priced at a yield of 4.95%. For a country with such a recent history of default, ratings still well below investment grade, which has not seen positive economic growth in over five years, the bond deal was pretty remarkable. As little as nine months ago, yields on Greece’s 10 year restructured bonds were over 11%.  As early as yesterday morning, a car bomb exploded outside the Bank of Greece in Athens, apparently in protest of the expected offering.  And yet investors could not get enough of the new deal, which was reportedly 8x oversubscribed. Yes, Greece was a rock star.

But maybe this is indeed a life of illusion.  A bond that had € 20 billion in demand only yesterday should probably be trading higher, as investors round up their positions. But no, the bond looked like it traded up a little, and then moved steadily lower throughout the day.

Back in the U.S., Investment Grade Credit seemed impervious for most of the past week to the global macro sell-off that’s been going on. Credit spreads have hardly budged – until today, when they finally showed some signs of weakness.  Total returns were positive through yesterday, driven primarily be lower interest rates, leaving the broad credit markets up nearly 1.0% for the week.  With rates down again, total returns should remain positive, but we expect excess returns for the week may dip into negative territory.

Supply was about $21 billion, about the same as last week, and dominated by global and 144a issuers, as U.S. Corporates enter their pre-earnings blackout periods.  Credit Agricole was one of the larger issuers, bringing $3.0 billion across a 5 year fixed, 5 year floater, and a 10 year.  The 10 year priced at +130 (which is tighter than Goldman Sachs current 10 year), and moved a few basis points tighter today in spite of the overall market weakness.  The market is much more comfortable with the safety of the French bank – perhaps in part since it disposed of its Greek subsidiary Emporiki in a transaction completed just a little over a year ago.

Was Emporiki a timely disposition? Or has Greece achieved sufficient reform to get its economy on track? We’ll see how it all pays out, but my guess is that it takes more than a coat of paint to turn an old jalopy into greased lightening.