Credit staged a meaningful rebound in July as geopolitical risks and a volatile macro backdrop took a backseat to strong corporate earnings and an improved supply/demand picture for IG credit. While the macro issues – notably EM concerns, a rise in Chinese corporate defaults, trade wars and new U.S. sanctions on Russia and Turkey – continue to be a source of concern, a light new issue calendar coupled with historically low dealer inventories kept the supply/demand balance in check. On the supply side, new issue volumes were down significantly due to a big drop in M&A-related issuance. Investment grade supply was only $67 bln in July, compared to $120 bln in June and an average YTD monthly run rate of $122 bln. The technicals were good in July, but eventually supply will pick back up and the transition from QE to QT should lead to more spread volatility. The fundamentals, which have been overshadowed by the QE-led technicals, should be a better determinant of spread moves going forward. While earnings have been good on a year- over-year basis, we have not seen that translate into better credit metrics as the majority of the benefit of tax cuts and repatriation has gone to shareholders.
July Excess Returns of 1.2% a YTD Best
Source: Barclays Capital
Light Dealer Inventories Exacerbate the Moves in Both Directions
Note: Federal Reserve data until July 2018. Estimated using Trace in Bloomberg afterward.
Source: Federal Reserve, Trace, BofA Merrill Lynch Global Research
Earnings For IG Issuers Up 21.6% YoY
Source: BofA Merrill Lynch Global Research
Earnings Growth For IG Issuers by Sector
Source: BofA Merrill Lynch Global Research, FactSet
Index Performance: The credit index tightened 13 basis points in July, reversing all of the widening that occurred in May and June.
The index OAS of +103 is now in the middle of the YTD range (+81 to +117) but still much closer to the tights (+81) vs. the mean (+166
10yr mean). Both excess (+1.20%) and total (+.72%) returns were positive on the month as significant spread tightening offset higher
Treasury yields. As such, the credit index yield of 3.92% was only two basis points lower on the month. YTD excess returns improved to
-0.38% while YTD total returns remain in deeply negative territory at -2.29%. Both duration and beta outperformed in July. The bid for
duration improved, resulting in marginally flatter credit curves as longer dated corporates outperformed (-18 bps). By ratings quality, the
BBB portion of the index outperformed (-16 bps) driven by higher beta sectors like wirelines (-25 bps), energy (-20 bps), and sovereigns
(-18 bps). The best performing sector in July was cable (-26 bps) as better than expected subscriber trends (video subscription losses
moderated, healthy broadband adds) and clarity around the Fox assets helped spreads remediate. The FOXA/DIS/CMCSA saga is
nearing its conclusion as Comcast pulled out of the bidding war for Fox and is now focused on winning the SKY assets. This outcome
is probably the best bondholders could have hoped for as it greatly reduces the amount of debt that would be issued if both the
Fox and Sky assets were purchased by one acquirer (either cmcsa or dis). Moreover, the odds of CMCSA holding its (low) single A
ratings (at least at two out of three agencies) is now greater than 50%. Within energy, midstream outperformed (-25 bps) as positive
earnings results and progress on de-leveraging efforts for credits like KMI and ETP caused the midstream vs. independent E&P basis to
compress. One of the major themes for the midstream sector this year has been the simplification of corporate structures with several
consolidations announced this year including ETE/ETP, WMB/WPZ and SEP/EEP/ENB. These structural consolidations are creditfriendly
transactions that improve cash flow by re-sizing distributions and eliminating IDR payments, thereby providing companies with
more balance sheet flexibility and ability to de-lever.
July Credit Index Returns
Source: Bloomberg Barclays
Spread Changes by Sector
Source: Barclays Capital
Credit Index OAS of +103 Is Closer to the Tights vs. the Mean
Source: Barclays Capital
June Investment Grade Supply: July supply volumes were only $67 bln, a big drop from the $119 bln in June and the lightest month so far
this year. M&A-related issuance was only $1.3 bln in July, compared to an average YTD run rate of $22 bln per month. We expect M&Arelated
issuance to pick up as the pipeline of pending deals remains elevated. July supply volumes were dominated by financials ($50.9
bln) as several banks issued post earnings including JPM ($6.5 bln across two maturities, 6nc5 priced @ +105/5yr, 11nc10 priced at
+135/10yr), BAC ($6 bln across two maturities, 6nc5 priced @ +110/5yr, 11nc10 priced @ +140/10yr), and Citi ($5 bln total comprised of
3yr fixed sr bank @ +77 and 30yr holdco @ +170/olb). New issue concessions collapsed to 0-3 bps by the end of the month as demand
improved.
IG Monthly Supply Volumes
Source: BofA Merrill Lynch Global Research
HG Monthly Supply Volumes
Source: BofA Merrill Lynch Global Research
Pipeline of M&A (Enterprise Value)
Source: BofA Merrill Lynch Global Research
Cumulative IG Supply ($bln)
Source: BofA Merrill Lynch Global Research