Stock Markets Volatility and Credit Spreads dynamics
1. EDITORIAL
March had been characterised by important decisions made by the Central Banks that
will have ripercussions on investors’ choices and their portfolios.
The ECB made decisions about its QE program on a quantitative (raising the amount of monthly repurchases, from 60 to 80 BN euros per month) and on qualitative side (the bond base had been widened including Investment Grade corporate bonds).
FED on the other hand went against the last December thoughts and Janet Yellen gave a dovish speech on the last meeting on interest rate policy.
These two decisions had a a sudden impact on the markets. Exchange rates against the USD and the Emerging Markets’ currencies aligned immediately to the next US monetary policy (USD weakened and EM currencies appreciated in value).
Meanwhile in Europe the spreads on the bonds tightened.
Stock markets reacted basically with a US reaction and paired the losses yer-to-date while in Europe, political uncertainty and lights on the financial sector, left the market still in the red zone.
Some Emerging Markets gained sprint from the recovery of the commodities rout and especially those linked to oil production, such as Russia and Brazil.
Gianluigi Montagner
2. STOCK MARKETS VOLATILITY AND CREDIT SPREADS DYNAMICS
What the fundamentals of markets tell us is the Eurozone markets are quite good, but investors will have to get accustomed to very high volatility in financial asset prices, especially on the prices of equities and corporate bonds.
Let’s try to look at the reasons. Liquidity on the markets (due to the Monetary Policies put in place) will be ever more abundant, so the size of capital flows that buy or sell different asset classes will certainly increase; economic uncertainty will be significant mainly because of the Chinese growth and the RMB’s exchange rate, the usual oil price and, in a correlated manner, the EUR’s exchange rate, the political and economic situations in major emerging countries and Japan.
Other reasons will be the political uncertainty coming from the Brexit referendum on June, political tensions linked to the reforms in Spain and Italy and also the refugee crisis and, last but not least the US Presidential elections.
The ECB may add some reasons to the uncertainty scenario: what will it do if core and expected inflation do not pick up? And what will it do, conversely, if the oil price continues to rise? ECB will ought to face a big monetary dilemma that will increase the volatility on the markets. So the crucial point will be volatility management for investors’ portfolios.
Elevated financial market volatility was the fil rouge of this first quarter, amid a sharp decline in Chinese equity prices and oil prices. This environment led to a downward repricing of riskier financial assets, with spreads of High Yield (HY) bonds increasing more than Investment Grade (IG) ones. But the spread between High Yield and Investment Grade yield rose, the average corporate bond yields had been substantially unchanged (see Figure 1).
Credit spreads gained a pick up due to a fall in government bond yields. Yields on 10yr US Treasury Notes and Deutsche Bunds both dropped by 48bps year-to-date, to 1.75% and 0.12% respectively as per 6th April. The drops in risk free rates partly reversed due to these causes: oil prices rebounded, economic data in the United States showed and the ECB stimulus eased investors’ fears.
Figure 1 – EUR HY/IG OAS Spread Ratio [HY: iTraxx XOver EUR (ITRXEXE); IG: iTraxx MainEUR (ITRXEBE)]
Improvements in monetary and credit dynamics gained momentum due to Interest rates cuts and the programmes put in place by the ECB such as the targeted longer-term refinancing operations (TLTRO) and the expanded asset purchase programme (APP).
The targets of the ECB policies has been primarily SMEs of the Eurozone as this type of enterprises provide two thirds of the jobs in the region and even more in peripherals countries. On the other end, the extensions of the Asset Purchase Programme to Investment Grade euro-denominated bonds issued by NFC is goin’ to focus on larger firms.
The policy divergence between the FED and the ECB should reinforce the thoughts of the investors to prefer European credit spreads versus US credit spreads. The expected scarcity of EUR IG NFC bonds due to ECB’s purchases has pushed their prices higher conversely pushing down the yields. The following day after the ECB announcement European credit spreads for Investment Grade (IG) and High Yield (HY) tightened, by 13bps and 46bps respectively.
Investors should focus on much tighter spreads on these asset types as the details of the programme will be detailed in the near future.
Figure 2 – Spreads HG & IG [HY: iTraxx XOver EUR (ITRXEXE); IG: iTraxx MainEUR (ITRXEBE)]
If the economic data coming from the United States signal a possible and sustained growth, the economic recovery in the euro area is continuing but with some signals of slowing down; otherwise the GDP in real terms grew by 1.6%, its strongest increase since 2011.
The continuing improvement of the economy in the Eurozone should stimulate risk appetite and thus drive spreads tighter.
But investors should keep an eye on this and especially that the economic recovery in the Eurozone is mainly domestically driven so the Equity sectors that should benefit are those exposed to cyclical recovery such as Consumer Staples, Consumer Discretionary and Utilities, or to globally exposed sectors, such as Chemicals, Industrials and Technology.
Spreads’ compression within Energy, Materials and Mining sectors should benefit from the shift from investment to consumption based growth, from the China’s demand of aluminium, copper, nickel and zinc and from the increase in oil demand (global based).
Cristian Rusconi
3. DATA TO WATCH
US
- 12th April: NFIB Small Business Optimism
- 12th April: Import Price Index MoM & YoY
- 12th April: Monthly Budget Statement
- 12th April: MBA Mortgage Applications
- 12th April: Retail Sales Advance MoM
- 13th April: PPI Final Demand
- 13th April: US Crude Oil Inventories
- 14th April: Initial & Conitnuing Jobless Claims
- 14th April: CPI MoM & YoY
- 14th April: Bloomberg Consumer Comfort
- 15th April: Empire Manufacturing
- 18th April: NAHB Housing Market Index
- 19th April: Housing Starts & Building Permits
EU
- 12th April: CPI MoM & YoY [UK]
- 13h April: CPI MoM & YoY [FRA] & Industrial Production MoM & YoY [EZ]
- 14th April: CPI MoM & YoY [EZ & ITA]
- 15th April: Trade Balance [EZ]
- 19th April: ECB Current Account [EZ]
- 19th April: ZEW Survey Current Situation and Expectations [GER] & ZEW Survey Expectations [EZ]
- 20th April: Jobless Claims Change [UK]
- 20th April: ILO Unemployment Rate and Employment Change [UK]
- 21st April: ECB rates decision [EZ]
- 21st April: Retail Sales [UK]
- 22nd April: Markit Manufacturing PMI, Services PMI, Composite PMI [EZ]
- 22nd April: Retail Sales [ITA]
- 25th April: IFO Business Climate, IFO Current Assessment, IFO Expectations [GER]
- 27th April: GDP QoQ & YoY [UK]
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