Thursday, 21 February 2019

Strange world

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  • Strange world

The discussion regarding the relative merits of euros versus US dollars has created a rollercoaster ride that looks set to continue in a market that both confounds and confuses.

The world is a strange place. While hardly a unique insight, it can offer a crumb or two of comfort, when explaining the inexplicable, to recognise that there are sometimes no clear answers and that we are all at times simply stumbling around in the dark.

A prime example of the bond market’s ability to bewilder with aplomb can, for instance, be found in the SSA market last year, as sovereigns, supranationals and agencies alike mulled the benefits of issuing debt in either euros or US dollars.

When ECB president Mario Draghi announced in January 2015 his intention to roll out a European-style quantitative easing programme, one might have expected a few more global SSAs to favour the single currency over the greenback.

And so they did – in a way. Over the course of 2015, a total of €297.6bn of euro-denominated debt was printed by SSAs of all stripes, according to data from Thomson Reuters. By far the heaviest quarter, in volume terms, was the first three months of the year, as issuers rushed to make the new QE era count. Fully 40% of all debt issued in the single currency by SSAs last year was printed in the first quarter, with sales falling off notably sharply as 2015 wound to a close.

Dollar sales meanwhile started the year with a bang, stealing a march on euro prints. That metric was reversed once Draghi unveiled his €1.14trn quantitative easing programme.

As winter turned to spring, euro sales ticked up nicely, said Yu-Miao Yang, director, European SSA syndicate at Barclays. That, she said, “lasted until the beginning of the summer months, when absolute low yields saw a deceleration of euro issuance”.

This, of course, is all grist to the mill for proponents of ECB efforts to inject growth into the slowly improving eurozone, while giving a much needed boost to prices and wages.

So, it might come as a surprise to find that euro-denominated sales by SSAs actually fell 18% year-on-year in 2015. Or that prints in the single currency in the first three months of 2015 totalled €121.5bn: a considerable improvement over the previous two lacklustre quarters, but a decrease in volume terms, on a year-on-year basis, of 12.2%.

Hike anticipation

Then there is the paradoxical final three months of 2015, during which everyone from bond traders to emerging market policymakers sought to anticipate and price in the first hike in US interest rates in nine years.

Many assumed that dollar prints by global SSAs would tail off sharply, for a couple of months at least. That in turn became presumed wisdom, so much so that bankers began converting that assumption into truth.

“In the summer of 2015, people started pricing in expectations of a US interest rate hike, meaning that many saw the dollar as a poor place to be,” said Mohit Kumar, head of interest rate research and strategy at Credit Agricole. “That rotated a lot of SSA investors and issuers back out [of dollars and] into euros.”

Kumar is hardly alone in presuming that euro prints must have outstripped dollar sales by SSAs in the waning months of the year. Barclays’ Yang pointed to the deluge of bad news that buffeted investors and traders when they returned from their summer break, from slowing growth in China and persistently low energy and commodity prices, to rising speculation about the Fed’s internal timetable.

Those stories made it very difficult for issuers to access the dollar market. Yet the truth, again, is somewhat different. True, dollar bond sales by SSAs fell by 18% quarter-on-quarter in the last three months of the year, to US$109.8bn. But euro-denominated sales fall faster and further, declining 21%, to US$59.5bn in dollar terms.

Europe’s decision belatedly to bend its knee to the influence of a monetary policy it once mocked also reinforced the parochial nature of the single currency, at least in terms of its allure to the wider issuing world.

Europe-based SSAs accounted for 96.2% of all euro-denominated prints in 2015, a share that was flat over the previous year. Compare that to North America-based SSAs, which made up 46% of dollar-denominated sales in 2014, and 61% in 2015.

The dollar, it seems, remains the playground of nations and their leading supranational and agencies (assuming that most developed-world sovereigns continue, for practical and political reasons, to print in their indigenous currency), while the euro is the provincial hunting ground of European SSA issuers – and virtually no one else.

What, then, can we expect going forward? If recent history teaches us anything, it is, it seems, that most predictions are worthless.

Not long ago, it was assumed that the December 2015 rate hike by the US Federal Reserve would be merely the first of many.

“When 2015 drew to a close, the market assumption was that we had started a phase of rate normalisation in the United States,” said Barclays’ Yang. “Those predicting three, four hikes for 2016 are now scaling back their expectations. This, combined with the developments out of Bank of Japan and dovish comments out of the eurozone, will impact dollar SSA demand.”

Eurozone uncertainty

There is uncertainty in the eurozone too, where Draghi faces the prospect of being firmly impaled on the horns of a dilemma. A decision to ramp up the ECB’s mass bond-buying programme in March will concern investors if it fails adequately to bolster both prices or growth. But if the scale and pace of QE remains unchanged, investors might take fright, further undermining the single currency.

If there is one theme that is likely to remain consistent in 2016, it is that of tenor. Ponderous eurozone growth has in recent years persuaded sovereigns, supranationals and agencies to issue ever longer dated euro debt, with dollar prints erring toward the shorter end.

Pierre Blandin, head of SSA debt capital markets at Credit Agricole, expects that phenomenon to remain firmly in place through 2016.

“We are likely to see SSA dollar sales remain strong in the two to five-year section of the curve, while euro-denominated sales will remain strong from seven years upward,” he said. “If you need to issue bonds beyond seven years, the euro is really your only port of call. European interest rates will remain low for a long period of time, pushing demand further and further along curve as investors strive to secure even a smidgeon of extra yield.”

Said Barclays’ Yang: “In the dollar SSA market, most of the issuance is in shorted dated tenors.”

To Credit Agricole’s Blandin, a key factor influencing the tenor of dollar prints will be the relative strength of data out of the United States, including economic growth, the strength of the energy sector, and consumer price inflation.

“Investors are for now being a touch cautious on anything longer than five years on the dollar side of the market,” he said.

If there is an interesting wrinkle in the fabric of this asset class over the course of the year – one that shifts activity away from one of the world’s dominant hard currencies and toward the other – it may occur as emerging market-based SSAs (as well as developing-world corporates) look to cut the cost of repaying their outstanding debt.

“Since 2008, US$4trn in dollar debt has been issued by non-US institutions, and with the dollar continuing to strengthen and global financial conditions tightening, that debt is becoming harder to service,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole. “We’ll see more issuers coming to Europe to swap increasingly expensive dollar debt into euros. That is going to be a big factor affecting the euro-or-dollar market this year.”

If there is a saving grace for the world’s leading issuing currencies, it is their status – for now at least - as a safe haven in a stormy world. Oil and commodity prices are still bouncing along the bottom, Beijing is struggling to stem capital flight, while Brazil and Russia look set to remain mired in recession until at least 2017.

“This is driving money out of high-beta emerging markets and into safer assets, ensuring we see high volumes of SSA supply denominated in both euros and dollars,” said Demetrio Salorio, global head of DCM at Societe Generale. “We could see a huge amount of new SSA debt issuance this year in both currencies, particularly when it comes to sovereigns.”

So which market will take the bragging rights this year?

Credit Agricole’s Marinov said: “Euro issuance has become more attractive than dollar funding in recent quarters and that should continue. Societe Generale’s Salorio, meanwhile, said he expected to see a “more balanced market” emerge, with regular, sizeable prints in both currencies. Credit Agricole’s Kumar said issuance in would remain strong throughout 2016, with “euro sales just taking the edge”.

But how valuable, really, is any prediction about this conundrum of an asset class that regularly and reliably manages to confound and confuse? We will have to wait and see.

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