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Squeeze On

6 January 2017 by Pierre Beniguel

Fixed income markets have started the year as they finished it, with strong demand pushing prices higher. The BAML Euro HY index has already tightened by 20 basis points in the first three trading sessions of the year, with the spread to worst rallying to 358bps.  To put this into context, it’s the tightest spread achieved since September 2014, while the post-financial crisis low was 294bps in May 2014; however, at that time government bond yields were much higher and therefore the yield available was 3.45%, the yield on the index today is just 3.2%.

The main culprit for this is the low level of new issuance in the higher yielding space; with ECB support having been extended in December and without any new negative macro drivers emerging, the lack of supply exacerbates the pent up demand. So far this year, there has been no issuance from a corporate high yield borrowers, and the subordinated banks market has only seen one deal in the AT1 space.  So far, the pipeline appears light for the remainder of January as well.

The AT1 new issue that we have seen came from the Italian lender Intesa Sanpaolo, and the on-going rally and low level of primary issuance certainly helped the successful placement.  Demand for the deal, which is relatively long dated with a 10 year call, was strong and books were about 4 times the size of the new issue, allowing a small increase to €1.25bn, while book runners also managed to tighten price-talk from 8-8.125% initially and to a 7.75% coupon.  When you consider the perilous state of the Italian banking system, this was a great result – Intesa Sanpaolo is undoubtedly the strongest bank in Italy, but its 7% coupon AT1, with only 4 years to call, was trading at a yield above 9% at the beginning of December!

In corporate high yield, we are still waiting for the inaugural 2017 issue. Last year, new issuance, or lack thereof, was also a driver for performance as, according to the BAML Euro High Yield Index, the market contracted by 6.3% or €19 billion in notional terms.  Indeed, 2016 was only the second time in ten years that the market contracted; in 2008, it contracted by 1.5% in notional terms, as the financial crisis began to bite.

New issuance levels is obviously not the only force at play and last year we saw a lot of market drivers, however as we experienced in the last two months of the year, the low level of issuance, combined with higher cash balances, lends a lot of support even when other potential macro disturbances are present, such as the US election or the Italian referendum vote.

So far, this is a very different start to last year, where fixed income markets experienced a very difficult first month, and in some case, the worst performing month of the year.  Twelve months later, in stark contrast with last year, should investor sentiment remain unchanged and primary level remain subdued, we could see strong gains in the first weeks of this year.

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