European Central Bank president Mario Draghi might have disappointed financial markets in December when he failed to deliver all of the extra stimulus many had been expecting, but most participants in the public sector bond markets believe conditions will settle down in time for January — always a key month for bond volumes in the SSA sector.
Nicola Mercusa, senior capital markets officer at the European Investment Bank in Luxembourg, thinks that for issuers such as the EIB, which has been a beneficiary of the ECB’s public sector purchase programme since it was first introduced in March last year, it will be business as usual.
“The market is getting used to it,” he says. “We know the ECB will buy and will continue to purchase massively. Of the €60bn a month they intend to buy, 12% is bonds issued by supras and agencies, and of this, EIB bonds are around 40% of the eligible outstanding. So we know our bonds will be in fairly high demand.”
The market has spent almost a year adapting to ECB quantitative easing and without vast changes to the programme in December, most believe it will able to continue operating as before.
In essence, the asset purchase programme has been extended in length but not depth, with the PSPP now set to run until March 2017 or beyond if necessary.
However, one change that the ECB did make was to extend its purchase programme to include municipal and sub-sovereign bonds. This will benefit Germany more than any other eurozone member, as it has the largest proportion of sub-sovereign and municipal debt in Europe.
The inclusion of municipal debt was the one thing which the market expected. It was met with approval and there was little initial movement in German regional debt as it was largely priced in.
The purchase of Länder debt is expected to take some pressure off Bunds, a move which has been welcomed by some bankers. “They did it to alleviate the concerns about Bund liquidity,” says Eric Cherpion, head of global bond syndicate at Société Générale. “It was quite a smart move. They’re basically substituting governments with municipals but the assets have the same quality. I think it is healthier for the market to have rates that aren’t frozen at zero.”
One feature set to remain in 2016 is elevated premiums, though issuers are now well adapted to them.
“What you are seeing now is a two tier market where the secondary levels, for agencies particularly, are some way through what they are being asked to pay in the primary markets,” says Graham Pointer, director of public sector debt origination at Citi in London. “We’ve seen a trend for a while now where new issue premiums have gone out to around 10bp for fairly straightforward looking deals in the worst cases. Before QE it would have been just a basis point or two.”
While he thinks issuers feel they have been on the back foot when it comes to the pricing of concessions since QE, by late 2015, premiums, while elevated, had settled around the 5bp-6bp mark for benchmark euro deals.
Size matters
And others believe that the heavy volumes of expected supply in euros in the new year will nullify premiums.
“Large-scale supply in January should help mitigate the possible effects of QE,” says PJ Bye, head of SSA syndicate at HSBC in London. “When you have a large new issue pipeline secondaries tend to cheapen back closer to fair value, hence lowering the necessary premium.
Like Bye, Mercusa believes the high volume of issuance will aid the EIB’s ability to access funding without difficulty. “We are one of the largest issuers in euros and we will be able to adapt to new market conditions,” he says. “Last year was a tough year for the euro market — particularly in the first half. Uncertainties will be many in 2016 but we don’t have particular reasons to be worried.”
In fact some issuers have suggested that the December sell-off, which has steepened curves, will aid their access to the capital markets.
Municipality Finance is considering printing a euro benchmark for the first time this year and Joakim Holmström, head of funding at the Finnish agency, says that the fact that PSPP would be in place for all of 2016 was helpful.
“The euro curve steepened after the press conference, so it should be a bit easier to do a 10 year euro benchmark, but even now the 10 year swap rate is still below 1%, which is a historically low level,” he says. “But at the shorter end interest rates have moved into negative territory, so the natural reaction for investors is to go for duration.”
Bankers agree that more palatable yields would aid their business in 2016.
“Had yields fallen significantly into year end,” says Philip Brown, managing director, capital markets at Citi in London, “investors may have perceived less value in fixed income. We remain bullish on European rates for 2016. Higher yields will help us to sell bonds in January, so this market reaction is not unhealthy in that respect.”
The long and short of it
Issuance is expected to be focussed on the long end in euros, with the seven and 10 year being favoured maturities, but negative yields up to five years could still be an option for some of the more established borrowers.
Erste Abwicklungsanstalt, a German agency which does not fall under the PSPP, proved there is investor appetite for bonds with negative yields when it printed a €1.5bn 2018 note with a yield of minus 0.11% on November 30.
The borrower was even able to increase the size of the deal from a planned €1bn after such strong demand.
There may also be issuance at the ultra-long end. The hunt for yield played out in the enormous support European Stability Mechanism received for its 40 year transaction printed in November last year.
As the ECB only buys debt of up to 30 years, the 40 year was deemed to offer good value and the ESM was able to increase the deal from an expected €500m to €1bn.
Several investors changed their mandates in order to be able to buy the bond. Bankers on the deal said that investor demand for ultra-long debt would remain into 2016 and that other supra--nationals were considering issuing in that tenor.
Choosing euros
In addition, the divergence in monetary policy between the US and Europe is another contributing factor to the expectation that euros will be the currency of choice for SSA issuers in January.
The US Federal Reserve was widely expected to raise rates in December and deeply negative swap spreads are set to remain.
Five year swap spreads moved into negative territory in late October, falling from around 6bp in early October to minus 11.85bp on November 20. The negative swap spread means that dollar issuers would have to pay up to offer a palatable spread over US Treasuries.
Intraday dollar swap spread moves have been volatile and until the market stabilises, bankers believe it will mean euros are the preferred currency. In fact, swap spreads are expected to be pushed further into negative territory in January.
“When issuance is heavy, swap spreads get more negative as you have all these issuers looking to swap from fixed to floating,” said a London-based SSA banker. “So in January, I expect they will still go in the wrong direction.”
