We highlighted a few weeks ago that markets might be heading for a period of increased volatility, and that the catalyst could well be a move higher in risk-free yield curves.
This is in fact what is currently occurring, and today we have the hugely important US employment data to digest, so the volatility could well persist a little longer if this data is shown to be strong.
The move in risk-free curves has not been large, but it’s the pace of the move and the starting point in this low yield backdrop that is causing investors’ angst.
Since the beginning of August the biggest mover has been the Gilt curve, with the 10-year yield moving from 0.60% to 1.12%. Behind that is the Treasury curve with its 10-year benchmark yield moving from 1.17% to around 1.60% as of this morning. Lagging slightly is the euro curve, with the equivalent Bund yield moving just 35bp from -0.50% to negative 0.15%. These are relatively small moves, but duration is highest when yields are low, so a 50bp move is roughly a 5% drop in price - certainly significant when there is little to play for in terms of yields.
The reason markets are jittery though is that the bulk of this move has occurred since September 22, and this has fed through to all risk markets. Staying with the world of fixed income, yields in high yield bond markets around the world are broadly 20bp higher in the last three weeks, and in more volatile sectors such as Coco bonds they are up by around 30bp. Again not huge, but enough to post negative returns.
Interestingly, the bond supply calendar has ploughed on regardless and new issues in this period have had to come with a premium as you might expect, in particular in the sterling market where the risk-free move has been highest and inflation fears are perhaps most concentrated now. For example, Modulaire, a single-B rated industrial group priced a multi-tranche deal this week with the euro portion carrying a 4.75% coupon and the sterling tranche offering 6.125% for the equivalent risk. Even adjusting for currency hedging the sterling deal came 75bp cheaper.
Sticking with sterling, we also had new issues from UK pension buyout specialist and well-followed name Rothesay. The perpetual non-call 10.5-year came with a 5% coupon, when a month ago Rothesay probably could have achieved 50bp less. Another example is property developer Keepmoat, whose six-year bond came at 6%.
So in our view new issues are coming with a healthy premium, particularly in sterling but also in euros and dollars.
This looks to us like a buy-into-the-dip opportunity, but investors should be wary of taking on too much rate sensitivity as the move in risk-free curves is likely to persist until the rate hike cycle is actually on the way.
The fundamental case for buying credit remains fully intact in our view, and I won’t bore readers again with the rationale, but one interesting new statistic is that in August in Europe there were no downgrades in either high yield or investment grade. I don’t think I can ever remember that happening before.
In the meantime, look out for today’s US employment figures. This is one of the most closely watched data releases anyway, but this print has a lot of relevance for ascertaining the rate of job growth relative to the Fed’s parallel goal of full employment.