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Euro Corporate Bond Market Is "Tenacious Bubble," UBS Says

Submitted by Tyler Durden on 04/08/2015 14:55 -0400

Towards the end of last month, we discussed a Barclays note which suggested that QE in Europe is driving investors into corporate credit as yields on euro govies tumble under the weight of the ECB’s perpetual bid. Here’s what this dynamic looks like in four simple charts:

The problem with this, as we’ve outlined exhaustively, is that the combination of shrinking dealer inventories and heavy investor demand has the very real potential to spell trouble should everyone who has been moving into corporate credit to find yield in the face of what has been a 5-year-long episode of Central Banks Gone Wild suddenly decide, for whatever reason (e.g. an Austrian Black Swan, a Varoufakis fumble, or an "accident" near the Bab el-Mandeb), that they want out. Put simply: the secondary market isn’t very liquid these days.

Here’s the latest take on the subject from UBS:

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EU: A tenacious bubble

We believe the European corporate bond bubble is firmly entrenched. On the one hand, we believe a return to a global systemic financial crisis with the potential to trigger a wave of corporate defaults seems rather unlikely given the deleveraging and recapitalisation efforts accomplished by banks over the last few years. On the other hand, we think a return to sustainable growth and higher inflation that could see investors move out of fixed income assets into capital appreciative equities remains elusive. While European equities have seen large inflows in Q1 this year, European corporate bond funds have also seen a surge in inflows in January and February. Admittedly, signs of improvement in European growth have become harder to ignore lately, driven by the confidence-boosting QE announcement of the ECB, lower oil prices, a weaker euro and less fiscal drag in Europe. Our economists upgraded their 2015 growth outlook for Europe last month and now expect 1.6% growth this year up from 1.2% previously. That being said, while headline inflation is moving in the right direction, it remains uncomfortably low as per our economists. The renewed deceleration in core inflation shows that underlying price pressures remain weak, despite the improved confidence in the Eurozone business cycle outlook. From the ECB's perspective, a full return of HICP to the target of "close to but below 2%" is still a long way out. Against this background, any calls for an end of the QE programme before September 2016 would appear premature. Furthermore, Greece, Ukraine, domestic politics and slow progress in structural reforms remain key risks to the European growth outlook. So, while the scenario of a return to sustainable growth and inflation in Europe over the coming quarters looks more probable it still remains a distant prospect. Nevertheless, we believe such a scenario would have the potential to “burst the corporate bond bubble” as bond yields would rise with inflation, corporate confidence would run high and a releveraging/deterioration in credit metrics would materialise resulting in bond fund outflows. The lack of liquidity in corporate bond markets would make the process particularly painful. Away from a global systemic financial crisis or return to sustainable growth, other risk scenarios wouldn’t have the potential to “burst the bubble” per se, in our view. These scenarios would more likely result in selloffs of variable magnitude over a limited period of time.

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To get an idea of trends in supply, here's a look at euro IG and HY issuance over the last several months:

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Wed, 04/08/2015 - 14:57 | 5972156 Chuck Knoblauch

China HUB it.

Wed, 04/08/2015 - 18:26 | 5973101 max2205

Corp bond exit doors are a lot smaller than govt bond exit doors

Wed, 04/08/2015 - 23:22 | 5974015 blowing winter

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Wed, 04/08/2015 - 15:03 | 5972186 Spungo

Bubbles are good for the economy.

Wed, 04/08/2015 - 15:04 | 5972191 NoDebt

I remember when a savings account paid what "high yield" bonds do now.

I'm going to head up on a nice hilltop somewhere and bury myself. I've clearly outlived my usefulness. Nobody wants to hear shit like that. I'm not sure anybody under 30 would even believe me.

Wed, 04/08/2015 - 15:17 | 5972271 Dr. Engali

Yep, and now we have the Swiss issuing debt with a negative yield. Crazy days indeed.

Wed, 04/08/2015 - 15:22 | 5972299 KnuckleDragger-X

Yep, and that's the problem. The entire system has been bent up so badly, so long, that far too many people don't even comprehend that it wasn't always this way.

Wed, 04/08/2015 - 16:16 | 5972585 SirBarksAlot

Don't lose hope.

Remember the big bubble in the Wizard of Oz?

Wed, 04/08/2015 - 15:10 | 5972225 Kraut

It is depressing: Big banks and hedge fonds are called evil and stupid until they publish something the Tylers like, suddenly they are noble and smart.

Wed, 04/08/2015 - 15:19 | 5972279 Dr. Engali

Hey UBS, the bubble isn't in bonds, it's in dollars and euros. There are too many of them for them to go.

Wed, 04/08/2015 - 15:27 | 5972322 NoDebt

How could you say such a thing? it's totally normal when things like the entire world market for oil moves 6% IN ONE DAY. I see nothing but "fundamentals" driving rational, efficient market pricing.

Wed, 04/08/2015 - 15:19 | 5972288 buzzsaw99