Spreads remain stable as the primary market springs back to life

The summer break on the primary market for large-volume covered bonds ended on August 19, 2024. Following the break, the first new issues in the euro benchmark format met with mixed interest. Two German issuers focused on the medium maturity range, with the seven year new issue having a much harder time than the new five year pfandbrief. The three year new issue from the Netherlands performed best. In all cases, the new issue premium of less than 3bp remained at the low level seen before the summer break. The market currently appears to be open to issuers, though issuers are utilising unsecured bond formats more than covered bonds in the first few days after the break.

In our opinion, Canadian banks have still to catch up in terms of new issues. Since 2018, they have always been good for new euro benchmark covered bonds, with a volume of at least €10bn. So far this year, however, there have been Canadian new issues of just €5bn. For the market as a whole, we continue to expect the volume of new issues in the euro benchmark format to fall to €170bn in 2024 compared to €185bn in 2022 and €199bn in 2023. Accordingly, new issues with a volume of about €55bn are still expected in the remainder of the year. Euro benchmark covered bonds with a volume of around €30bn are still to mature by the end of 2024. If our expectations are correct, the market would grow by around €25bn.

The growth of the market must be financed by investors. To make matters worse, up to around €9bn of the aforementioned maturing covered bonds will flow back into the European Central Bank’s third covered bond purchase programme (CBPP3) from September to December and will therefore not be available for reinvestment. In the first half of 2025, CBPP3 maturities will increase to a good €28bn. The risk premiums for covered bonds must therefore remain attractive enough to draw sufficient demand.

Our hope that the risk premiums for covered bonds would narrow over the summer, when no new supply is offered, has not materialised. In recent weeks, the swap spread (z-spread) of the iBoxx € Covered index has fluctuated within a range of 35bp-37bp. Following the summer break, the z-spread has so far moved sideways within these limits. At this spread level, new issues appear to be attracting sufficient investor interest, meaning that we expect spreads to remain stable despite the anticipated net new supply of around €25bn by the end of the year. At the moment, the yield level and the prospect of falling interest rates are supporting demand for covered bonds. At the same time, the unclear path of the US economy, the smouldering conflict in the Middle East and the close race in the upcoming US presidential election, for example, are uncertainty factors that could lead to higher volatility in yields and spreads. All in all, stable z-spreads on the secondary market are the most likely scenario for us in the coming weeks. Volatility should mainly be seen in the primary market in the level of new issue premiums and possible stop-go traffic.

Following the European elections at the beginning of June, the risk premiums of French covered bonds widened the most compared to covered bonds from other countries. During the summer break, French covered bonds were unable to make up the lost ground. In the current environment of stable spreads, we see some potential for French risk premiums to catch up with the overall market over the next six months. We therefore recommend overweighting them within the iBoxx € Covered index. For most of the other country indices within the iBoxx € Covered, we expect a performance in line with the overall index. More generally, over the next three and six months, we anticipate the z-spread of the iBoxx € Covered index will remain at the current level of around 35bp. Over the course of the year, we expect the environment to brighten and the z-spread to narrow slightly to 30bp.