Global Weekly: Another eventful week

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Needless to say, we have seen another eventful week of economic news. Oil prices crashed, as the May contract price for WTI oil per barrel fell to USD 40 below zero after North American storage capacity reached its limit. North Korean leader Kim Jong Un was said to be in critical condition, raising the question of who could take his place and what this might mean.

There was lots of speculation on eurozone policymaking – will we see any sort of joint eurobonds? In any case, new support programmes keep coming, with many governments announcing fresh or additional packages, while the ECB has decided to loosen its collateral rules to accept ‘fallen angel’ bonds. A fallen angel is a bond that has been reduced to junk status because its issuer has fallen into financial trouble. Meanwhile, macroeconomic data and earnings season results are showing the severe impact of the corona pandemic on the economy. All this leaves core yields somewhat unaffected, however, as the major central banks have effectively moved to yield-curve control, keeping long rates pinned close to policy rates – which is why we are sticking to our neutral stance on duration. For spread products the situation is very different, though.

In the European periphery, spreads are widening again, led by Italy, but with Spanish government bonds also widening significantly. It seems reasonable to think that the coronavirus, which is hitting these countries so severely, could result in rating downgrades. Eurogroup leaders will meet on Thursday evening to discuss how the EU should fund the financing needed to fight the virus and its negative economic impacts. With the periphery pushing for joint bonds – pretty much the only thing that is likely to be unacceptable for other countries, led by Germany and the Netherlands – a definitive solution does not look close to hand. This could lead to widening periphery spreads, which in turn could trigger spread control by the ECB in the shape of a decision to expand the Pandemic Emergency Purchase Programme (PEPP) at their meeting next week (or potentially sooner). In this situation, we consider a neutral stance on Italian government bonds most appropriate along a wide spread range; but should spreads reach 350 bps, we would be inclined to move to overweight.

The ECB is doing everything in its power to support markets, and its decision to loosen collateral rules might open the door to fallen angel bonds being included in the Corporate Sector Purchase Programme (CSPP) as well, just as the Fed is doing in the US. We think this would be very helpful to keep BBB bond spreads under control, and would further support the investment grade corporate market. The strong rebound we have seen in the past few weeks means there may now be some downside risk again in the event of economic or corona-related disappointments, but longer term we remain positive as spreads are compensating for the increasing numbers of fallen angels we will be seeing this year.

Following the Fed’s decision to buy not only investment grade corporate bonds but also fallen angels, the high-yield market has been rallying as if this is also a market supported by central banks. We disagree, however, as it will only be the fallen angels and BB rated bonds that profit from this move. Lower-rated corporates, which are more in need of help, will not benefit from this development (the Fed will also buy some high yield ETFs that include these bonds, but in amounts too small to have any market impact).

We expect default rates to rise, especially in the US shale oil sector that was already vulnerable (we reckon the plunge in the WTI oil price confirms that this sector will remain under enormous pressure); and, after the recent rebound, spreads are not compensating for this. We are thus sticking to our preference for emerging markets debt (EMD) over high yield. This market is also vulnerable to oil prices (although more to Brent than to WTI oil), but less so for countries and corporates with higher ratings and more buffers and diversification. These should be better able to cope with the oil price environment than the low-rated, pure-play US shale oil corporates in the high-yield market. Moreover, many emerging markets are oil importers that should benefit from low prices.

A negative oil price

Volatility on equity markets has dropped since the start of the month, but daily market moves can still be very big. Stock market reactions are being triggered not only by the evolution of the corona pandemic, other factors also come into play. The deep decline in oil prices was one of those main events last week.

As production exceeded storage capacity, WTI oil futures (May contract) sank into negative territory – something not seen even during the Great Depression of the 1930s. Brent oil dropped below a 21-year low. Despite collapsing oil prices, the energy sector had a decent week in performance terms, both in Europe and the US. Meanwhile, authorities and central banks still are exploring new paths to support the economy. In Europe, the ECB plans to accept junk-rated debt as collateral for lenders, apparently in anticipation of Italy’s debt becoming junk going forward.

After the US financial sector kicked off the earnings season last week, more corporate results were reported from a variety of sectors. Low visibility due to corona impacts and uncertainty about the timing of easing precautionary measures was one common point in almost all corporate communication.

German IT services company SAP warned that because of postponement of client capex, new business is expected to be on the weak side. Margins on cloud business, by contrast, showed good growth. In health care, Roche’s sales came in 2% above expectations in the first quarter. The Swiss company also maintained its guidance for 2020. In consumer staples, two global players, Danone and Coca Cola, published quarterly figures. Food producer Danone benefited from increased consumption at home during the restaurant lockdown, but there is a lack of visibility for the rest of the year. Coca-Cola made the same point on the upcoming quarters, but has seen volumes drop by 25% since the start of April. Kimberly-Clark enjoyed a strong move on the back of heightened demand for its paper products as consumers stockpiled, with consumer tissue volumes up 14% and personal care up 7%.

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