Falling rates pose threat to Swiss franc bond momentum

On paper, 2024 looks to have been a vintage year for the Swiss franc bond market. After a record 2023, the pace of new issuance rose. As of mid-November, Sfr65bn ($73.6bn) had already been printed — almost Sfr2bn ahead of the same period in 2023.

However, it was a year of two contrasting halves. After a strong start, interest rates fell over the summer — leading issuance volumes to fall from Sfr43.7bn between January and June to Sfr21.1bn in the period from July 1 to November 15.

As fixed rate takers, Swiss issuers benefit from lower interest rates, so opportunistic domestic borrowers tapped the market in the second half of the year. However, falling rates, coupled with widening spreads made it more challenging for the Swiss franc bond market to compete with those in other currencies.

“Given the increased domestic spread levels, a big chunk of foreign supply didn’t materialise,” says Benjamin Heck, head of syndicate at ZKB. “The Swiss franc widened, so the market wasn’t competitive with other currencies, which tightened.”

As a result, domestic names have played a much stronger role in the market in 2024, accounting for almost two-thirds of total issuance. In 2023, this balance was closer to an even split.

Collective covered bond issuers Pfandbriefbank and Pfandbriefzentrale are often used as the benchmarks for the market. Both have had a difficult year, as spreads on their bonds widened.

“Spreads are really distorted,” says Andreas Tocchio, head of Swiss syndicate at UBS in Zurich. “I have not seen them come so wide in 20 years, with the exception of the first weeks of Covid lockdown. [This is] not explainable from a relative value perspective, but is instead explained by supply and demand.”

Investors are reaching their limits for the two issuers. As cash availability dwindled in the second half of 2024, they sold paper in the secondary market to free up capital for new issues. This sell-off has pushed spreads wider.

“It is the new normal; if you want to raise money, then you have to offer the spreads,” says Michael Wölfle, head of debt capital markets at ZKB. “[But it has been] quite shocking to see and it makes it difficult for the rest of the market too.”

Rosario Clemente, head of DCM Switzerland at Deutsche Bank, and Damien Aellen, head of Swiss syndicate at BNP Paribas Switzerland in Zurich, both highlight the widening spreads on Swiss government bonds as another reason for price widening.In mid-2023, govvies were trading at 100bp through swaps; now they are trading almost flat.

Spreads on all high grade names have pushed wider as a result of widening Pfandbrief spreads. The spread differential between high and lower grade names has been compressed and the differential in credit risk is not reflected in pricing. “We need to see how that will balance out,” Aellen says.

One knock-on effect has been a nosedive in foreign covered bond issuance.

Sabeen Munir, head of Swiss syndicate at Commerzbank, says that Pfandbriefe “still set the floor for covered bond pricing, so any other issuers will need to pay a premium”.

“Spreads on Pfandbriefe have widened so much that, even if you are a top quality issuer, flat to them is not competitive and investors are not willing to concede on the premium,” she adds.

Martin Schmid from Münchener Hypothekenbank’s treasury — which has natural funding needs in Swiss francs — says that “if spreads develop in our favour, then we would shift to issue some Swiss covered bonds and reduce our covered bond plans in euros accordingly.” However, for now, it is too expensive compared with euro funding.

Tocchio expects that at least some natural correction in Pfandbrief issuance will occur in 2025. “Next year will be a different ball game,” he says. “Yes, 2024 was clearly overdone in terms of volume, but 2025 will be adjusted to the new rates environment.”

Clemente expects that issuance will remain high as falling rates stimulate new mortgages. The Pfandbrief issuers “don’t have another market to diversify into”, he says.

In many ways, 2024 was a story of corporate bonds. By November 15, corporate issuance was more than Sfr5bn ahead of the same period in 2023.

The capacity of the market has been tested, with Nestlé, SwissCom, Thermo Fisher and Novartis raising more than Sfr1bn each in the first half of the year, among a host of other benchmark deals.

While domestic issuers are responsible for 69% of 2024’s supply, foreign issuers have still raised more than Sfr7bn — up Sfr2bn on last year.

The Swiss market “can be nimbler than others on size to price ratio,” Aellen notes. Corporates are looking at the Swiss franc as a means of diversifying and getting a “proper chunk” of funding done without paying up, he says.

“There has been some dislocation in the euro market, so issuers are looking for relative pricing,” Munir says. “Corporates are looking more at diversification. They have seen that things can look ugly quite quickly, so they want access to all markets.”

“Foreign corporates will remain active and I would expect to see good issuance next year,” she adds.

Heck expects that the large domestic corporates will be active through 2025 too. “It will depend on cross-currency swaps,” he says, “but they are fond of printing benchmarks in their core market, if economically sensible.”

Although falling interest rates have stymied issuance in the second half of 2024, “low rates do create opportunity,” according to Munir.

“Spread-yielding products are more interesting to investors, so we can go deeper into market segments that were previously less relevant, like tier two bank capital,” she says. “A vein of emerging market issuers is also more likely to open when the rates backdrop is lower.”

Triple-B rated corporates have benefitted from investors looking further down the credit curve in search of spread, while emerging market borrowers have taken a larger slice of the market over 2024.

Fonplata, a South American development bank, tapped the market twice over the course of 2024. Rafael Robles, Fonplata’s CFO, says that the market’s ability to be competitive on price and flexible to the issuer’s funding needs ensures that it remains an important source of capital.

Commercial Bank of Qatar, Engie Energía Chile and Metro de Santiago were among other EM names to issue in the Swiss market in 2024, with all three opting to issue green bonds.

Metro de Santiago was one of five Chilean issuers to tap the market, making its debut in the currency in October. Guillermo Muñoz, president at Metro de Santiago, emphasised the company’s commitment to ESG, but added that he “knew that there was a special value [in Switzerland] for companies issuing green bonds. The final price and size of our deal balanced well and the way we achieved that balance was by issuing in green.”

In November, London’s Heathrow Airport issued the first Swiss sustainability-linked bond by a foreign issuer. Green and social bonds have accounted for more than 10% of total issuance.

Clemente expects that the appetite for green bonds will continue in 2025, noting that “in volatile markets, issuing a green bond is a very good tool to reduce execution risk.”

Heck agrees: “The price impact is negligible, but it brings more volume to a deal.”

Investors will still be keen to buy green and will continue to refine their views on these products, he argues.

In March, the Swiss National Bank surprised many by making a 25bp interest rate cut, ahead of both the ECB and US Federal Reserve. Further 25bp cuts followed in June and September.

One further cut was expected at the time this article went to press — and how far the SNB will go in 2025 is one of the big questions the market faces.

“In 2025, SNB cuts will depend on the Fed most importantly,” Munir says. “There are quite a few voices saying that there are too many cuts priced in and inflation could creep in, especially with the situation in the Middle East. But all else being equal, it should be a more stable picture for 2025.”

Aellen hopes that 2025 will bring stability to rates: “Away from [the euro/franc rate], there is no catalyst for rates to be higher or lower, so we need to accept that they will stay roughly where they are.”

While the prospect of negative rates is a concern for many, an unforeseen geopolitical event is generally considered to be the biggest threat to the market for the coming year.

For the most part, 2025 is expected to be challenging, but the market remains optimistic. “It is safe to say that we will see lower volumes,” Clemente says, “but this will not be a massive drop, just a correction from very high levels. We might see more volume from foreign FIG issuers, which have seen a drop this year.”

Heck expects that liquidity will pick up again in January. “The market should find a better balance again, with investors and issuers having the same idea of spread,” he says.

Tocchio also expects some repricing of the market, noting that the volume of international issuance will depend on the extent of this. “Yield will be key — whatever pays spread will have the focus of investors,” he says.

Tocchio expects that this will bring triple-B rated names and longer tenors into favour— but create challenges for high grade names such as supranationals and agencies.

Despite acknowledging the challenges ahead, Aellen expects that the market will continue to offer arbitrage and size flexibility, bringing new names to the Swiss market.

Munir agrees “it will be important to keep the market competitive and open to as many issuers as possible. To lose that would be the biggest threat to the market.”