“I could have been a very rich man,” said the Irish taxi driver while driving through Dublin Port tunnel in early November. “If I had put a fiver on Brexit, Trump winning and the Irish beating the All Blacks I would have won me €15m!”
Ireland had the weekend before beaten New Zealand at rugby for the first time and the country was feeling pretty chipper about itself when GlobalCapital paid Dublin a visit to suss out its financial centre credentials.
Dublin taxi drivers are famously talkative. But our man had a point. 2016 was, by any standards, a year of extraordinary shocks after the British and American electorates voted to overturn the established order.
Not that debt capital markets seemed to care much. There was some volatility immediately around these events, forcing issuers to pick windows of opportunity, but the soothing flow of central bank money helped to ensure that most key debt markets held up well — indeed, volume was better than expected.
Bomb-proof (after Q1)
Some sectors even outdid 2015. After an appalling first quarter, when issuance slumped as the world cowered at the plunging Chinese equity market, sovereign, supranational and agency bond issuance topped $1tr for the year, beating 2015’s $928bn total by some distance.
SSAs stretched out their maturities in euros or bagged tight pricing at the short end of the dollar curve. Green bonds broke the $75bn barrier, seeing the first ever sovereign issuer, Poland, in December.
Corporate treasurers had funding conditions in euros to tell their grandchildren about. Investment grade corporate bond issuance in euros hit a record of over €300bn, beating the exceptional harvest of €285bn in 2009 and last year’s €270bn haul.
The total was swelled by €65bn of deals from US companies taking advantage of Europe’s super-hot credit market.
For the first time, some companies were even able to price straight bonds at negative yields. Dismayed by this, some investors changed their mandates to allow them to buy higher yielding debt.
Bank of America Merrill Lynch thinks volume could hit €325bn this year, another record, driven by an increase in mergers and acquisitions. Bayer, for example, will need to issue about $37bn of debt if its $56bn takeover of Monsanto goes through.
The CEEMEA bond market also had a storming year, with $155bn of issuance by December 12, sharply up from $86bn in 2015, driven by a big increase in borrowing by Gulf sovereigns and Russian borrowers. These included the sovereign and some companies that are not sanctioned.
Latin American bond issuance was also sharply up on 2015, totalling $122bn by mid-December, against $73bn the year before, pushed along by a rejuvenated Argentina and borrowers from the Andean countries.
It was a quiet year for leveraged finance, partly because private equity firms shied away from using their huge piles of dry powder when equity valuations are so high.
There are different ways of counting the market, but according to BAML, European issuance of high yield bonds fell 19% in 2016, to €52bn, while leveraged loan borrowing came down less, from parity with bonds at €64bn in 2015 to €56bn.
It was a volatile year for risk assets, so conditions were not extremely attractive for issuers, but the bigger problem was issuers turning their noses up at the market — except when it came to returning to the loan market for aggressive repricings of loans, only a few months after they had first been signed.
The keen loan market stole some volume from high yield, too. BAML predicts both sides of the market will pick up in 2017, to €60bn of bonds and €65bn of loans.
FIG crimped
Financial institutions have also been issuing fewer bonds — of all kinds. Covered bond output fell 15% to €150bn equivalent in 2016, as banks needed less funding and could get some of it from central bank funding schemes.
Senior issuance shrank by 11% to €192bn, partly for the same reason, and partly because banks had to wait for clarity on loss-absorbing debt regulation. This also put a crimp in tier two issuance, down 8% at €33bn. They will at least get a steer on this in 2017, as the European Commission has proposed a harmonised bank creditor hierarchy based on the French model.
Additional tier one issuance fell 23% to €23bn, hit by market volatility, in particular during the first half of the year when there was confusion around the capital stacking order and fears that certain banks, including Deutsche, would be unable to pay coupons on their AT1 bonds.
Steep declines
But the real disappointments came from syndicated loans, equity capital markets and — to some extent driving the other two — M&A.
Global announced M&A in 2016 had reached $3.6tr by December 13, according to Dealogic, down from $4.6tr in 2015. The figure for completed deals shrank less, from $3.8tr to $3.5tr.
M&A is a very big source of loan volume, and particularly of loan market revenue, and in Europe especially is an important contributor to ECM activity.
JP Morgan expects M&A to turn up slightly this year, to $3.9bn, driven by finance remaining at cheap levels, record private equity dry powder, Chinese outbound M&A continuing to grow and US acquirers being emboldened by a strengthening dollar and a weakening euro and pound.
It cannot come soon enough for the EMEA loan market, where, with the refinancing cycle ending, volume fell from $1.36tr in 2015 to $862bn by December 13.
ECM squeezed in some big deals between patches of market turbulence, but China-related turmoil spoiled January and February, the Brexit vote disrupted June and July and markets were unsettled in the autumn too, with a string of IPOs pulled.
Volume in EMEA had been €171bn by December 12, against €280bn for the whole of 2016.
Riskier and riskier
But all those involved in global capital markets know forecasts for this year are barely worth the research papers they are printed on.
They face another year of extreme volatility, risks and shocks in 2017, perhaps even more so than 2016. That means it will be another year of opening and shutting issuance windows for borrowers and investors across all markets. It will be a good year to be nimble, agile and flexible.
Europe has crucial elections coming up in France, Germany and the Netherlands. After the surprise results of the US election and UK referendum, and Matteo Renzi’s more predictable self-immolation in Italy, political uncertainty will be a key theme this year. Markets are likely to close in the lead-up to the votes, and depending on the results, afterwards too.
And while the ECB has already announced that it will start tapering its asset purchase programme from €80bn a month to €60bn (but has extended it by six months), further tapering rumours could be disruptive and lead to excessive front-loading of issuance.
Meanwhile, Britain will stumble and lurch towards its exit from the European Union. The High Court appeal ruling on whether the government requires parliamentary approval to trigger Article 50, due by the middle of January, will be one of the market’s first pressure points of the year. After that, speculation around the timing of Article 50 and potential hard or soft Brexit will surface frequently, causing heightened volatility in sterling and euro markets.
Donald Trump’s election as US president will bring uncertainty and tighter financial conditions in the months to come.
The base case is that 2017 will be a painful year for bond investors and an exciting one for equity buyers, as the Great Rotation finally comes to pass.
Trump may struggle to get his infrastructure spending plans going, but tax cuts shouldn’t be hard — the Republican Congress will love them.
That will fuel asset prices and consumer spending — great for cyclical equities, which have already zoomed past the yield stocks investors have loved for the past five years.
Dollar bonds face a year of falling valuations and some volatility, as the Federal Reserve decides how many more rate rises will follow the second in this cycle, which took a year to materialise.
The memory of the steep 425bp of rate hikes the Fed had to do between 2004 and 2006 after the long easing that followed the dotcom boom and September 11 terrorist attacks — and the economic pain it led to, especially in the US housing market — are likely to weigh heavily on the Fed governors’ minds. Some may decide it is best to get on with it as soon as possible.
US inflation doubled from 0.8% to 1.6% between July and October 2016, and unless this eases soon, the Fed hiking cycle is likely to be aggressive.
Can a world that has grown used to invisibly low interest rates cope with much higher ones? Perhaps, if the economy is growing fast. But there are certainly bears who say the economic growth cycle is nearing its end and the combination of inflation and rate hikes could spark a recession.
Equity investors will hitch a ride on the reflation trade, and that will be great for banks and natural resources companies wanting to come in from the cold and raise some capital. But look out for the backlash when that trade eventually peaks.
How can the Dublin taxi driver get rich in 2017? Buying Dublin office space is one bet — the omens for a soft Brexit are not good. But for a triple accumulator, how about the 10 year Treasury yield hits 3.5%, China’s stockmarket goes up at least 40% and falls the same amount and one more country calls a referendum on leaving the EU?
