Crowds and QT ‘something to look forward to’ for SSA issuers

Although sovereign, supranational and agency borrowers can look back on 2023 as a difficult year well navigated in the bond market, they will have barely any respite before facing a new set of obstacles in meeting their 2024 borrowing needs. Some of those will be new versions of old problems — contending with interest rate volatility and diminishing support from central banks. Others will be unforeseen, as March’s banking crisis and the outbreak of war in October the Middle East were in 2023.

The effect of quantitative tightening (QT) was something that almost all participants in GlobalCapital’s SSA market survey agreed was likely to be the biggest disruptor of issuance at the end of last year. They were proved right: QT, aided by uncertainty surrounding inflation and growth, drove spreads wider and new issue premiums higher as order books and deal sizes shrank, notably into the autumn.

Therefore, it was perhaps no surprise that the acceleration of QT remains a concern for 15% of respondents in this year’s survey as the market prepares for 2024.

Key to navigating the primary market will be dusting off the playbook of yesteryear. Issuers and bankers alike should be reminded of “pre-QE issuance styles and best practice,” says Lee Cumbes, head of DCM for EMEA at Barclays. “With central banks reducing their balance sheets, there will be less money in the system. The price of that money has also changed and therefore the best way to access it is likely to be different. This should be part of all of our thinking and approach to markets going into 2024.

“There have already been signs that the euro market has changed recently and it is important to have those lessons in mind when we start next year, so we avoid risks of learning by trial and error — especially when there is a lot of uncertainty, whether that be rates, geopolitics or other factors.”

Survey respondents were also wary of other factors that could derail issuance, with geopolitical uncertainty (25%) and ‘higher-for-longer’ rates (25%) topping the list, followed by concerns over an unforeseen crisis (18%) and an economic recession (17%).

“With large issuance volumes, ongoing macro uncertainties including on interest rates and QT also weighing on the markets, 2024 will continue to be challenging, but we are not worried,” says Ioannis Rallis, JP Morgan’s head of SSA DCM.

“It will not be an easy market, but we have proved this year that it is a market that we can navigate. It will be about finding the right trade at the right time with the right price that can engage investors.”

Despite a tough final quarter in the euro market, the single currency was still the main funding avenue for SSAs and accounted for about two-thirds of overall benchmark issuance as GlobalCapital went to press.

Issuers also had to take a more flexible approach to deal execution. Some decided to set initial pricing a couple of basis points wider than usual. Others chose not to tighten the spread with any aggression — if at all — to maintain their order books and ensure secondary market performance.

“We are still finding our way through to the end of QE, which is not something that happens overnight,” says Mark Byrne, managing director, European debt syndicate at TD Securities. “In the euro market, the distortions are still coming through but in a relatively orderly way. There have been patches of difficulty but deals are getting done, and both issuers and investors are adapting. And I think we will continue to see that [next year].”

At the same time, market participants also recognise the opportunities that QT presents.

There are two sides of the coin when it comes to QT, says Benjamin de Forton, senior DCM SSA banker for EMEA at BNP Paribas. “It shouldn’t be seen as purely negative, because it should reduce the distortions in a market that was too accustomed to QE,” he adds. “Spreads may be wider initially, but there will be more bonds available, which will be a positive especially to well rated sovereigns, as the improved secondary liquidity will lead to a normalisation of their curves.”

“After years of being spoiled by QE, we are returning to a market where investors would look at issuers on a credit basis and take the time to do some digging — and it is something to look forward to,” says Kerr Finlayson, head of FBG syndicate at NatWest Markets. “There will be trades that will be difficult to do, but it’s exciting at the same time. The market could be tough and issuers will have to be nimble.

“But the exit of QE is also creating an exciting opportunity for some issuers — for example, dollar-based supras — to return to the euro market, with their curves normalising versus the ECB-eligible European peers.”

The dollar market served as a reliable funding source for many euro-based SSAs in the second half of 2023. Not always the cheapest source of funding, it nonetheless provided larger size — or sometimes simply smoother execution.

Benchmark issuance in dollars as of mid-November was already a quarter higher than the full year volume for 2022, according to data compiled by GlobalCapital.

Nearly half of survey respondents (47%) believe that the dollar market will continue to provide a more reliable funding source for SSAs that have access to both markets in 2024, with only 13% voting for euros. The remaining 41% think the two markets will serve issuers equally well.

The result looks starkly different from that of last year, when 45% thought euros would be the more reliable out of the two markets.

The dollar market has proved strong both in terms of demand and comparable cost of funding, and will continue to provide a safer backdrop for execution, given the slightly more advanced rates cycle in the US, Finlayson says.

Byrne too expects dollar execution to continue to be robust and for the currency to provide a good alternative for issuers. “It’s part of the biggest themes we have seen this year, which are diversification and flexibility,” he adds. “Issuers’ ability to move across different markets — including also the Australian dollar, Canadian dollar and sterling — is going to be key next year.”

But that is not to say the importance of the euro market to SSAs should diminish by any means. “It depends on how you look at the two markets, by what metrics, and at which part of the curve,” de Forton says. “But while the backdrop may be stronger in the dollar market, the euro market is still very important for issuers to access a spectrum of maturities. Issuers had been overly reliant on euros in 2022 and we have seen that normalising a bit.”

Most respondents (52%) believe SSA issuance volumes in 2024 will stay more or less flat to 2023, but nearly 30% predict heavier supply. Most, however, believe that the volume increase will not exceed a fifth higher than 2023.

“The market is on track for another busy year ahead, and the curve should continue to steepen,” Finlayson says. “In a normalising market, we will likely see the investor base go back to what attracted them historically — for example, for bank treasuries to focus again on the five year sweet spot, and for asset managers and insurers to reduce a bit of duration.”

The sheer amount of issuance, its implications for a primary market calendar already littered with economic data releases and central bank meetings, as well as spread performance, constitute a major concern for issuers.

“Our top concern would be the heavier supply calendar, which could potentially impact spreads,” says Sam Dorri, managing director, Total Fund Management, at the Canada Pension Plan Investment Board.

In addition to higher issuance from traditional tier one borrowers, Dorri expects Canadian borrowers to do an extra 15% compared with 2023, which he admits is “not an enormous amount” but still “a bigger number in what might be a challenging year”.

He is concerned that supply will drive levels wider and that they will widen in leaps and bounds rather than gradually. “More supply could also impact investor behaviour, with investors potentially more inclined to delay investment for wider spreads at a later stage,” Dorri adds. “In turn, this could impact how issuers with conventionally less market access may approach the market, which may have a spillover effect on the sector.”

Three-quarters of respondents believe issuers will front-load their borrowing, as they did in 2023, while 9% think they will do so even more actively.

Many issuers, including KfW, the European Financial Stability Facility and Land NRW, secured bigger amounts of funding in the early part of 2023. They also scouted for other possible funding opportunities to help navigate data releases, central bank meetings and unexpected risks. Most issuers were therefore in a comfortable position heading into the summer, with some of the largest borrowers, including the European Investment Bank, able to wrap up their benchmark funding in as early as September.

Widening spreads were another headache for SSA issuers in 2023, cheapening by 10bp within a couple of weeks at the most volatile times and making new issue pricing more difficult.

Three-quarters of those surveyed believe that euro SSA spreads will continue to widen against swaps in 2024; 50% hope the widening will remain moderate at only a few basis points, but 25% fear that it could prove more significant at more than 10bp. Only 16% think spreads will be stable.

Volatile spreads have made assessing fair value — and subsequently, the appropriate new issue concession — more challenging for issuers.

Two-thirds of market participants surveyed by GlobalCapital believe that issuers will need to pay a higher new issue premium in 2024 compared with 2023, and 21% think that premiums will stay elevated throughout the year.

Paying the right premium was voted the second highest priority for SSA issuers in 2024 in the survey (18%).

Bankers believe that even if issuers sometimes must pay up in the primary market, they will be rewarded with secondary performance and subsequently, future buying from investors.

But the top priority for public sector borrowers in a potentially busy year for issuance will be about finding the right window and dealing with competing supply, which accounted for 33% of votes, followed by maintaining order book quality (16%) and increasing secondary liquidity (14%).

“It’s really important for issuers to come at the right time and at the right level, and that will hopefully also help improve secondary liquidity, which has had a tremendous impact on a lot of the issuers this year, as the majority of the market away from the few big names is very illiquid and not reflective of where investor interest truly is,” de Forton says.

The days of waiting for the optimal issuing window are gone — a new reality that SSA issuers will have to face well into the future.

“Funding officers used to look for pristine conditions, making sure all boxes are ticked when entering the market. But with ongoing volatility in the market, I don’t think we have that luxury anymore,” says Daniel Aagaard Pedersen, head of funding and investor relations, treasury, at KommuneKredit.

“There are fewer and shorter windows, and, from time to time, we will have to issue close to a key economic data release or when there is heavy traffic. We will see a congested market and it will become even more pressing for both larger and smaller SSAs to have more agility in 2024.”