Friday, 14 December 2018

The stimulus connection

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  • The stimulus connection

While the ECB’s QE programme is widely considered to have stimulated demand in the bond market it is hard to come up with a scientific reason for the linkage, although it has driven a search for yield.

Can you convince someone to change their view, after their good opinion is formed? It isn’t easy, particularly when dealing with a specialist subject, or an issue close to one’s heart. Try to find someone living in Russia who doesn’t see Nato as a primary threat rather than a crucial defence mechanism. Or a German economist willing to agree with the mounting body of evidence pointing to the failure of eurozone austerity.

Our very human denial in the face of clear, untrammelled logic seems to work at any level. Take the impact of the European Central Bank’s €1.1trn (US$1.26trn) quantitative easing programme on the region’s debt markets. By any reasonable measure, QE has proven a success. Growth has returned in fact if not yet in force to the eurozone (though whether this is mainly due to lower oil prices is open to debate). Prices are rising again, as is consumption.

But has stimulus boosted capital markets activity? Are issuers printing more debt now than a year ago, or in the waning days of 2014? Has QE inspired more corporates and sovereigns to rush to market bearing bundles of bonds? Are average maturities and print sizes larger now than they were in the early months of last year, when stimulus was but a pipe dream?

Ask senior bankers across the region and the answer to all of the above is an unqualified “no”. “It’s hard to come up with a scientific linkage proving that QE is driving incremental issuance,” said Morven Jones, head of EMEA DCM at Nomura.

Pierre Blandin head of SSA DCM at Credit Agricole said: “I don’t believe QE has had any impact on issuance volume in the SSA sector. Borrowers have typically set out issuance programmes long in advance and they aren’t going to change this because of QE. Despite QE, the euro does not necessarily provide the best funding costs.”

Cold hard data

These thoughts reflect the industry’s prevailing view. Bankers and investors see little if any reason to connect any additional debt market activity during recent months with stimulus. And this is odd, because an overwhelming body of evidence based on cold, hard data suggests the opposite is true.

In the current year to May 10, sovereigns issued €89.8bn worth of debt denominated in the single currency, against €80.2bn in the same period a year ago and €78.6bn in 2013, according to data from Thomson Reuters.

Corporate debt issuance has accelerated even faster, to €179.9bn in the year to May 10, against €159.9bn in 2014 and €139.4bn in 2013. Moreover, issuance is getting chunkier. Two years ago, the average print size was €617m; in the current year to May 10 it was €802m.

The truth is that QE has almost certainly boosted capital markets activity (it is impossible to deal in absolutes here, as there is no provable connection between stimulus and issuance) in ways both expected and unexpected.

By pushing rates lower, QE has convinced corporates and sovereigns to print debt with longer maturities. Credit Agricole’s Blandin said there was a “growing appetite among investors for longer-dated bonds and subordinated debt”.

Lower rates, said one banker, had “fomented a disproportionally high bid for longer-dated government bonds, with supply and demand pushing prices up while suppressing yields”.

Again, this is supported by hard data. Corporate bonds bearing tenors of 10 years or more jumped from 8% of total euro-denominated issuance in 2012, to 24% in the first four months of 2015.

Over the same period, the share of corporate bonds with tenors of five years or less halved, to 18%. Some maturities are going super-long: on the last day of March, Spain printed a €3.5bn, 15-year inflation-linked bond with a coupon of 1%. In April, Mexico surprised everyone by selling the world’s first euro-denominated 100-year bond. The debut century facility, a €1.5bn print of notes with a 4.2% yield, was a direct attempt to lock in lower borrowing costs.

Another clear result of stimulus is a renewed hunger for riskier assets. This result was foreseen: low rates will tend to push investors to buy assets offering even a marginal pick-up in yield.

“Assuming yields and spreads remain low for a long period of time, any instruments that offer a very attractive pick-up should be of interest to investors,” said Credit Agricole’s Blandin.

Frederik Ducrozet, senior eurozone economist at Credit Agricole, described the “relentless hunt for yield” as the “dark side” of QE. When rates are at or below zero, he said, “investors are forced into riskier assets, which is something you are seeing since the start of the year. It’s not as if everyone is transitioning to Italian credits from German bonds but this is an ongoing theme.”

Hybrids’ popularity

Perhaps the epitome of this search for yield has been a spike in the popularity of hybrid debt, and rising demand for emerging market prints. In the current year to May 10, euro-denominated corporate hybrid issuance nearly doubled, to €13.14bn, from €6.7bn in the same period a year ago, according to Thomson Reuters data.

A prime example of this phenomenon was Total’s €5bn dual-tranche hybrid, issued in February. Rated Aa3 by Moody’s, it secured €20bn in orders while locking in record low coupons.

The fact that the French oil major had plenty of cash in reserve, and was under no pressure to raise capital or defend its balance, was perhaps further evidence of a correlation between QE and higher debt market activity.

“Investors are attracted to any asset that offers the best return,” said Brendon Moran, co-head of corporate DCM at Societe Generale. He pointed to a “halo effect from QE around corporate debt, especially high-yield bonds, corporate hybrids, and emerging market bonds, which offer the highest returns. Investors are attracted to any asset that offers the best return.”

Marcus Svedberg, chief economist at East Capital, points to the rising popularity of emerging market securities.

“We know that portfolio flows to emerging markets is increasing, which suggests that investors are rotating into riskier assets,” he said. “Portfolio flows to emerging markets surged to US$35bn in April, according to the Institute of International Finance, with the bulk going into equities and to Asia.”

Another curious by-product of European-style stimulus has been a spike in euro sales by blue-chip US corporates. This outcome was always possible, but the surge in activity has surprised even unbridled optimists.

“You’re still seeing big debt sales in the US, which is getting out of QE, so the parallel is not direct between QE and issuance”

“More than 20% of total euro-denominated debt this year has come from US corporates,” said SG’s Moran. “That’s been driven by absolutely low yields, a favourable euro-US dollar swap rate, and tight secondary spreads, all of which offer a good reason for US multinationals to look to the euro for best pricing and execution. Certainly, this was the case in the first quarter of 2015 in absolute terms.”

A notable example of this phenomenon was the €1.15bn print of 10 and 20-year paper in April by US pharmaceuticals giant Bristol-Myers Squibb. That deal, issued into a tricky market, was “a good example of a major US corporate raising in euros at low rates to repay some existing debt”, said Fred Zorzi, global head of debt syndicate at BNP Paribas. “That for me is an ongoing and continuing trend.”

Euro prints by US firms totalled €29bn in the first four months of 2015, against €9.5bn in the same period a year ago, and €38bn for the entirety of 2014.

Spread compression

Market practitioners may not believe that stimulus has had any impact on debt market activity – but it has. Whether this will continue into the second half of the year is anyone’s guess. After being pummelled through late April and early May, the global selloff in bonds slowed, leading analysts from Frankfurt to New York to tamp down fears of a crash. Yet some see that as a sign that the demand for euro-denominated prints has peaked this year.

“We’ll see less issuance in the second half, and that should support the market and lead to more spread compression later in the year,” said David Owen, chief European economist at Jefferies.

And to those who decry any correlation between QE and issuance, there is a body of evidence pointing to the fact that bond sales are doing well across the developed world, in countries both boosted by, and free from, stimulus.

Again, a smattering of added yield helps. Take AT&T’s US$17.5bn print in late April, the third-largest corporate debt issuance in history, a sale that granted investors a precious few percentage points more than similar-maturity US Treasuries.

“You’re still seeing big debt sales in the US, which is getting out of QE, so the parallel is not direct between QE and issuance,” said BNP Paribas’ Zorzi.

Beyond generous market conditions, there’s the subject of whether issuers of all types and sizes really need extra financing. Low rates are here to stay in the eurozone, probably for years to come; anyone placing a bet on the ECB hiking interest rates in the next 48 months is likely to get some pretty long odds. But will this encourage more issuance?

Bankers are sceptical. Said Nomura’s Jones: “The big driver of issuance remains whether [corporates] have a real need for the money.” Another leading London-based debt markets banker noted that making it easier to raise capital did not automatically presage a flood of new issuance.

“The thinking is that you’d be crazy not to issue at these rates, but you have to be careful looking at funding costs,” he said. “It’s not a free lunch, and all this money has to be paid back some day.”


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