Euro Corporate Credit: Just a minor reality check – Corporate credit caught a bit of a break last week. Spreads on the senior non-financial index dropped 2bp, after being subject to continuous upward pressure from early March onwards. The movements in credit have by no means been shocking, but momentum has been clearly negative recently.
Meanwhile, a measure of investor risk appetite improved more sharply: the Eurstoxx 50 VIX has come down to a level of 15 after reaching a peak of 35 in early Feb and the 15 level is in line with the average we’ve witnessed throughout 2017. So, why have we not seen a more pronounced pull-back in credit spreads back to the low levels seen in January? There is certainly no big pressure from new issuance and in previous episodes of VIX retrenching from 30 handles, credit spreads compressed more significantly.
We judge that the credit market might have ran ahead of itself in the earlier part of the year, so the re-pricing we’ve seen is justified. Indeed, Europe has been the region where economic data seems to have disappointed the most. Our economic data surprise index has come down sharply from a peak recorded in early February, the same point in time when spreads started to turn up. So it seems that credit investors have partially been pricing in the risk of a slowdown in economic growth. Although momentum in the economy seems to have reached a plateau, we do not expect a slowdown. Previous soft economic indicators were overshooting and reflected an unsustainable level of GDP growth. For example, Economic Sentiment and Composite PMI’s levels in the early part of the year would be consistent with a GDP growth rate between 3.5-4% (our growth forecasts for this year remained anchored at 2.8% however). Credit spreads followed the buoyant data and even pierced below our forecast of 40bp ASW.
We do not expect a bout of further credit widening in the non-financial IG space very soon. Firstly, we uphold our forecast at 2.8% GDP growth for the Eurozone, which still sits above trend level. Also our base case still holds for global synchronized growth and we do not expect protectionist tensions to escalate. Finally, QE unwinding will be gradual, well telegraphed to the market and there should be no material change in CSPP purchases for the upcoming months. (Shanawaz Bhimji)
US Macro: Retail soft patch is likely over – Retail sales in March grew by 0.6% mom, or 0.2% ex-autos (0.3% ex-autos and gasoline). The strength will come as a relief for those who were concerned by the relative softness we saw in the previous three months. While there appear to have been some one-off factors holding back consumer spending in Q1, for instance a delay in tax rebates in February, the weakness in our view more likely represented a levelling off in consumer spending after a period of exceptional strength in H2 2017 – for instance, private consumption expanded by 4.0% q/q saar in Q4 17, the quickest pace in three years. Higher oil prices have also likely had some effect, but given that gasoline and other energy goods spending represents a relatively small proportion of disposable income, the impact of this looks to have been rather muted. Indeed, having troughed at 1.8% of disposable income in early 2016, energy goods expenditure picked up to 2.3% as of February – still well below the post-crisis peak of 3.6% before the oil price crash of 2014-15. Overall, we think the fundamentals supporting consumer spending remain solid, with continued strong jobs growth, firming wage growth, tax cuts, relatively low household leverage, and still elevated consumer confidence among the many tailwinds. (Bill Diviney)