Supply to be the name of the game for SSAs in 2025

Sovereign, supranational and agency bond issuers — with a few exceptions — may have sailed through most of 2024 but found their market was on ever shakier foundations as the end of the year approached. Unprecedented swap spread moves have dragged SSA bond spreads in euros wider. Market participants insist that issuers should remain pragmatic as they embark on a challenging funding journey in 2025.

In GlobalCapital’s market outlook survey of SSA bond bankers, 58% of respondents thought the SSA market faces the challenge of absorbing an even higher volume of issuance in 2025 than 2024, in which supply was already heavy. In euro benchmarks alone, as of November 11, issuers had raised 22% more in volume terms than they managed in the same period in 2023.

For 2025, 31% of respondents predict overall issuance volume will increase by more than 10%, while the same amount think volumes will be about the same as this year.

Moreover, the market will be contending with the absence of the European Central Bank — through quantitative tightening (QT) — from the bond market as a large investor. Reinvestments made under the bank’s Asset Purchase Programme stopped in July 2023 and it plans to do the same for its Pandemic Emergency Purchase Programme (Pepp) from January 2025.

Supply pressure, including from the quicker pace of QT, also topped survey respondents’ concerns of what could disrupt the SSA market in 2025 (23.4%). Political uncertainty (22%) and geopolitical conflict (22%) were seen as the other biggest disruptors.

“Supply is the headline for next year and it will have a big impact on the market and the tone,” says Kerr Finlayson, head of frequent borrowers’ group syndicate at NatWest Markets.

“The volumes will come from the sovereign side mostly, as supranational and agency borrowers will be more or less flat to this year, or up only slightly, but the EU potentially has more to do,” he adds. “In any case, we won’t be starved for bond issuance next year, with QT in play as well.”

The EU has previously said its bond issuance programme will grow from this year’s record €140bn to €150bn-€160bn in both 2025 and 2026.

The issuer has run an active campaign this year and last to be considered as a sovereign — or at least sovereign-like — issuer instead of as a supranational. In GlobalCapital’s survey however, 73% of the respondents said they still view it as a hybrid of the two and 19% see it as a supranational. Only 8% consider the EU a sovereign issuer.

Although gross supply from SSAs is expected to remain unchanged, with the higher net supply due to QT, “there is still a lot of supply to be managed,” says Ioannis Rallis, head of SSA debt capital markets at JP Morgan.

“Borrowers will probably continue to front load,” he adds, “but the extent of it depends on how things develop over the next few weeks and how the beginning of next year looks in terms of demand and levels.

“There’s going to be competition for the best [issuance] windows, which was already fierce this year. The other question is how issuers would structure their funding given where spreads are.”

Most other market participants speaking to GlobalCapital also expect active front-loading to continue serve as a main driver of SSA issuer behaviour. About 76% of the 2024’s euro and dollar benchmark volume up until November 11 was printed in the first seven months of the year, according to GlobalCapital’s Primary Market Monitor.

Survey respondents also chose “Finding the right window and dealing with competing supply” (33%) and “front-loading as much as possible” (11%) as top priorities for SSA issuers in 2025.

“There’s a lot of expected supply next year and the free float of bonds out there is unlikely to change,” says Ben Adubi, head of SSA syndicate and DCM at Morgan Stanley. “With the impact of Germany’s election call and the administration in the US changing, a lot is coming back on the menu for European issuers issuing in dollars.

“Issuers who raced ahead and finished their funding earlier than usual were the champions this year and I can’t see much changing next year given how challenging market dynamics could turn out to be.”

A senior origination banker in London thinks different groups of issuers will plan according to what is going on in their own countries or be guided by their overall volume needs in 2025. “It depends on the issuer,” he says. “If you have a big programme to fund, you’ve got to be in the market every month so there needs to be a balance to it. If you’re more sectoral, or a French agency, it probably makes sense to see how spreads develop in the first few weeks of the year. A German issuer will want to be cognizant that an election is coming.

“It won’t be that everyone’s got to hit the markets in January. This year was very different because of the protracted US election cycle and the expectation that markets would probably close up before that, but on balance people probably pre-funded a bit too quickly this year.”

One school of thought is that the extra supply will drive higher returns for investors. “Yields should move to anticipate that supply,” says Finlayson. “Spreads should widen into the year end and we’ll start the year wide — wider than where we are now — and they will stay elevated in the early part of the year.

“With the continued trend of tighter swap spreads, there has to be some repricing, particularly with the end of Pepp redemptions on top of sovereign borrowing programmes.

“Swap spreads narrowing is clearly the big theme that we have to watch out for next year.”

The supply expectation and swap spread tightening may have an impact on how issuers look to structure their funding. “Some borrowers typically like to take a view on spreads and with spreads historically wide, they may conclude that they are more likely to tighten over the course of the year,” says Rallis. “If that is the thinking, then some of the more expensive projects — the long-term projects — will probably be held off until later in the year. Others may think of the current levels as the new norm so they may act differently.

“Personally, even though we are at the wide end historically, it’s difficult to have strong convictions about if and when we move tighter, as many the fundamental drivers seem here to stay.”

Swap spread narrowing has been rapid in the weeks before this report went to press. On November 6, after the collapse of the German three-party coalition government, 10 year Bund yields surpassed 10 year euro interest rate swaps, turning the Bund-swap spread negative for the first time.

That followed weeks of tightening for the Bund-swap spread, which drove widening in euro SSA bond spreads versus swaps. For example, the bonds of the EU, EIB and KfW had all widened 25bp-30bp at the 10 year part of the curve as of November 8 from where they were three months before.

Many in the market were hoping for some stability in the last few weeks of 2024. “A move [of spreads] of this speed and magnitude hasn’t been seen for at least the past decade, so some may argue that the moves are overdone and given the time of the year, there could be some stabilisation in the next six weeks, in some way, shape or form,” says Adubi. “If that does happen, then there are reasons to be more positive again in January.”

More than a quarter (27%) of survey respondents — with results collected in early November and before the latest leg of SSA spread widening — expect euro SSA spreads could widen by more than 10bp in 2025, while 35% anticipate a slight widening of just a few basis points. Meanwhile, 19% thought spreads should stay largely stable.

In terms of SSA spreads versus Bunds, there was no clear consensus. The biggest group of respondents (36%) expect them to tighten but 32% think they will widen. The other 32% think they will remain the same.

The euro market had been supportive for SSA issuance for most of 2024, even when volatility rose during the surprise French parliamentary elections in June and July. But the recent swap spread gyration and its effect on SSA spreads have left a sense of unease among market participants as they look ahead to 2025.

“There are reasons to feel nervous around January at this point, not so much on the large, liquid issuers like KfW, but on the smaller SSAs,” says Florian Eichert, head of covered bond and SSA research at Crédit Agricole.

“Many are trading 10bp through the large names, so it’s hard to imagine anyone would want to come out with 15bp of new issue premium versus their own curves. For the SSA market, this also has an implication on whether some issuers would want to do more dollar funding, not so much because of the cross-currency arbitrage but more from the execution risk perspective.”

Finlayson thinks that while the amount of new issue concession paid by issuers and the classic approach of starting bookbuilding 3bp-4bp back off fair value might not change in 2025, the key question is finding fair value.

“What we’ve seen this year was a break away from building fair value from an issuer’s curve, as liquidity became even more important,” he says. “So we are shifting away from looking at fair value on a micro basis to a more macro basis, with more focus on spreads to EU and France, for example.

“It also means that there is potential for investors’ views on fair value to be much broader than what we are used to.”

But there should be ample demand for SSA bonds next year, as long as spreads are able to find some footing. “Demand for SSAs in 2025 is of course affected by when spreads stabilise and at what level,” says Eichert. “For as long as they don’t, the market will have a very limited capacity to absorb even small volumes.

“And that’s the case not just for [liquid issuers like] the EU but for other SSAs, because investors need to have some confidence that spreads will not move another 15bp-20bp in the next 10 days. Once swap spreads stabilise, demand also for SSAs won’t be an issue.”

Adubi thinks that while the euro market felt softer as of early November, “it does put dollars back on the table across the curve for supras and agencies”.

A second origination banker in London notes that while dollar bond spreads have been relatively stable for SSAs, “the only concern we have is on the unbelievably tight spreads to US Treasuries.

“The sell-off has helped with higher rates attracting more absolute yield buyers,” he adds, “and the [asset-liability management] investors are still buying as it’s still quite attractive on a swap basis. We don’t see dollar SSA spreads cheapening too much, but that’s not to say the underlying market won’t change significantly.”

Only 23% of those surveyed believe dollar SSA spreads could tighten even further against US Treasuries in 2025. The rest of the market thinks spreads should either widen (39%) or hold steady (39%).

Before the latest euro market turmoil caused by the unexpected and rapid tightening of swap spreads, some 39% of respondents thought that the euro market should provide a more reliable funding source for SSAs that have access to both markets. About 31% thought dollars could be more reliable, while another 31% put an equal weight on both markets.