Shining brightly in market turnaround

Having heaped losses on investors during a miserable fourth quarter of 2018, risk assets rallied as the new year got under way.

The dramatic recovery came about because assets started to look cheap and investors were under-invested, although the biggest source of comfort came from Federal Reserve chairman Jay Powell, who called time on rate rises and even raised the prospect of loosening policy later in the year. Meanwhile, the European Central Bank also delivered a surprise on the upside, by appearing to postpone any rate rises of its own.

The result was a risk-on dash to the market by investors, and SSA issuers obliged by grabbing the opportunity with both hands. The strong market conditions paved the way for a torrent of supply, with most sovereigns well ahead with their plans for the year and the buyside pouring cash into issues across the board.

“We saw a fantastically successful first quarter with huge, high-quality order books as a procession of trades were snapped up by investors. Big-name sovereigns hit the market in size, while, as the market conditions continued into the second quarter, smaller agencies also enjoyed attention,” said one syndicate head.

The resurgence in supply followed a textbook pattern. Lee Cumbes, head of public sector EMEA at Barclays, said: “The first stage was led by large sovereign issuers, then supranationals and bigger agencies, then, finally, the smaller issuers increasingly entered the fray as investors chased spreads lower. By the end of March, the fourth-quarter sell-off was beginning to look like a bad dream. We are roughly back to where we were last October in terms of spreads.”

January kicked off with a mood of trepidation, particularly in the euro market, which received the most attention because it had suffered such a sharp drop in demand during the fourth quarter. Markets entered the new year full of apprehension that the end of QE was nigh and there were worries that the ECB, the world’s biggest euro buyer, was about to stop. In the US, the Fed was tightening and reducing its balance sheet, while the ECB ended its expanded sovereign purchases programme in December.

Bullish buying

While it is the investment community that ultimately facilitates issuance, it was the Kingdom of Belgium that grabbed the plaudits for taking the plunge on January 8 with a €6bn 10-year that attracted more than €28bn in orders. Ireland and Portugal tore out of the blocks the following day and, between them, these three trailblazers racked up €70bn of demand.

Having reopened the market, Belgium then returned on January 29 to print a €5bn 30-year that raked in €27.5bn of orders.

“That was a real game-changer. Investors were clearly happy to buy in the main benchmark maturity of 10 years, but the question was whether they would want to lock in rates at the long end. Belgium answered with a resounding ‘yes’,” said Cumbes.

The initial success of Belgium, Ireland and Portugal was too good for Italy to resist and it jumped at the chance to banish concerns over its own financing capacity, as well as those about the health of the broader market, with its €10bn 16-year.

Italy’s woes had begun to ease towards the end of the year with the approval of its budget. And when it garnered a near €40bn order book – its biggest ever – it became clear that any apprehension was misplaced. The sheer volume of cash pouring into deals showed that investors who had been on the sidelines since May last year were returning in force.

Spreads widened at the end of 2018, and the subsequent repricing brought new accounts back into the market. But few had foreseen the speed with which they would return and the volumes of supply that they would support.

“With spreads widening for SSA paper, on a mid-swap/asset swap spread basis, more bank treasury accounts are bidding for SSA paper,” said one syndicate head.

Sovereigns usually start proceedings with a bang, and this year was no different. Core sovereigns were early beneficiaries of the rally as part of a flight-to-quality bid, but this developed into more of a broad-based scramble.

“In recent weeks, the rally has also made the periphery much sought after because they are offering a bit of yield and spread,” said Asif Sherani, co-head of SSA and financial institutions syndicate at HSBC. “Investors are looking to get product that is offering yield, and they are doing that by either going down the credit spectrum or going longer in terms of the maturity spectrum. Whatever has been thrown at the markets, they’ve been able to absorb and come out all guns blazing.”

Issuers deserve praise for their nimble approach to accessing the market. KfW tapped the sterling market with two deals in rapid succession, realising that the swap costs versus its euro curve was working in its favour. The sterling market has performed strongly, with issuance volumes considerably higher than in the first quarter of 2018 (see separate story).

KfW has seized its opportunity in euros as well and, as a result, is well ahead with its funding plans despite increasing its programme to €80bn from €75bn last year. It has so far completed €35bn, while this time last year it had raised closer to €26.1bn. “That’s representative of how strong market conditions have been and how favourable opportunities have been for issuers,” said Sherani.

Volumes have increased sharply, even though in many other cases funding needs have reduced compared with last year. The issuance glut means issuers are well ahead of the funding plans for 2019, which gives them the flexibility to navigate any upcoming bumps in the road.

“We envisage ongoing strong demand, but issuers may need to be a bit more selective about when they come to the market,” said Cumbes.

Belgium, for example, has already completed 50% of its funding activities, while Portugal has come to market with two syndicated deals, matching its tally for the whole of last year.

“Clearly, the bulk of SSA supply has already been issued from a syndication format,” said Sherani. “But with market conditions continuing to be extremely favourable, more issuers could be tempted into the market sooner rather than later. If they don’t have huge funding needs, they may still come with smaller deals.”

Super supras

Until recently, supranationals had proved to be the laggards, but that was down to a lack of funding needs rather than an absence of desire to tap red-hot markets .

At an estimated €50bn, the EIB’s funding programme is some 17% lower than last year. More starkly, the European Stability Mechanism and European Financial Stability Facility have slashed their combined needs by almost 30% in 2019 – potentially the first year that no eurozone country will be dependent on a financial assistance programme.

The two are planning to raise €32.5bn in long-term borrowing, the former targeting €10bn and the latter €22.5bn. They borrowed €18bn and €28bn, respectively, in 2018.

“ESM/EFSF don’t need to fund the same volumes. If countries don’t need bailouts, you’re not going to see them fund to the same volume we’ve seen in the past. That’s where we’re seeing the decrease in terms of issuance,” said Sherani.

However, they kicked off the second quarter with a bang as EFSF came with a €3bn no-grow that offered a a 5bp new issue premium. That was sufficient to lure in investors, who poured €11.7bn of orders into the April 2035 offering. EFSF followed the EIB into the market, the latter attracting more than €13.4bn for a €3bn no-grow 7.5-year.

Trades from the EIB – which as at April 8 had completed half of its funding for the year – and EFSF were indicative of a growing appetite by issuers for capped deals as the second quarter kicked into gear.

“It’s rare to see so many no-grow deals,” said Sherani. “That shows you issuers want to take advantage of the funding but at the same time are cautious not to take too many funds on board because they’ve already done a lot of funding in Q1.”

Greece came to the market with its first 10-year bond in almost a decade, underlining both the sovereign’s improving status and the appetite for paper.

Its approach was textbook. The first deals were supported by investors comfortable taking more risk, such as hedge funds. Then, as yields performed, it found rates investors.

There is a debate to be had over whether the changing stance at the ECB and Fed are the only drivers behind supply. Portugal has worked hard to reposition itself, for example, while Greece has been through a very painful restructuring.

“The initial trades … were reflective of a more positive view of each individual credit,” said Cumbes. “The initial wave of supply in early January was supported by fresh cash allocation. Then economic data showed that growth was not as buoyant as hoped, delivering the realisation that euro yields would stay low and the rally looked increasingly sustainable.”

A stellar first quarter has left borrowers well positioned to ride out any volatility. Potential headwinds include the European elections at the end of May, plus concerns over a possible recession in the US prompted by the inversion of the yield curve. Any move to cut rates by the Fed would throw down the gauntlet to the ECB.

Rupert Thompson, head of research at KW Wealth, said: “Government bonds are telling a much less rosy story than equities and are a reminder that markets can be fickle and significant uncertainties remain. We believe some caution continues to be warranted.”