SSAs: Cheers as dollar curve opens and ECB keeps money tap on
Supranational and agency borrowers enjoyed enviable conditions in the bond market last year, with European Central Bank quantitative easing creating long end funding opportunities and a deep dollar market providing some big deals in the short end. But central bank actions could mean the environment is even better in 2018, writes Craig McGlashan.
Relief could be at hand for a public sector bond market that has been squeezed into short maturities in the dollar market and an increasingly packed euro market. Most analysts expect several rate rises from the US Federal Reserve this year — although estimates of the number vary — leading to rising long end US Treasury yields. That should support issuance in that part of the curve for the more expensive public sector borrowers that need those extra basis points of yield to entice investors.
There was a late flurry of strong 10 year deals in the final quarter of 2017, from triple-A names such as the Asian Development Bank, Rentenbank and the World Bank.
But even more could come, according to funding officials at similarly rated borrowers.
“We are very hopeful and positive for 2018 with respect to the 10 year part of the dollar curve,” says Otto Weyhausen-Brinkmann, head of new issues at KfW in Frankfurt. “We saw more issuance there in 2017 than 2016. I think we will see some normalisation in 2018.”
“We are constantly monitoring the 10 year part of the dollar curve,” says his colleague, funding officer Anna Scharffenberg. “If there’s a possibility for us to tap that part of the curve, we definitely will do so.”
Triple-A supranationals and agencies sold $9.55bn of 10 year deals of at least $1bn in 2017, according to Dealogic, compared with $7.75bn the year before — although the number of deals was constant at six. But the volumes are well below the previous two years, of $15.5bn in 2014 and $17.25bn in 2015.
Issuers that did not tap the 10 year part of the dollar curve last year will be keen to return, after watching regular visitors to the tenor reap strong demand when bringing new trades.
“We hope 10 year dollars stays open — since we’ve now done four over the past few years, our name should be connected with the tenor in investors’ minds,” says Leopold Olma, head of funding at Rentenbank in Frankfurt.
If the long end opens up, it could help avoid a logjam at the three to five year part of the curve — something that is likely to ease the scheduling of an SSA community that still has high funding needs, compared with pre-2008 financial crisis levels.
Moving across the pond
A shift to long end dollars could also ease some of the pressure on the euro market, which provided strong opportunities further out on the curve last year. That resulted in its biggest year for supranational and agency issuance since 2014 and also the first time since that year that it has outstripped dollars (see graph).
Further alleviation could come from one of the larger borrowers moving from being a euro-only name to adding dollars to its mix.
The European Stability Mechanism raised €11.5bn-equivalent last year and has an estimated €23bn target for 2018, but some of this funding will come through dollars this year. The supranational sold its debut bond in the currency in October — a $3bn five year — and plans to issue in the dollar market once or twice a year, building a curve from two to five years.
The European Financial Stability Facility — ESM’s sister issuer — will not print in dollars but its euro supply will also ease in 2018, to an estimated €22bn from a beefy €49bn last year.
This potential change to the currency supply dynamic will come at a time when euro monetary policy begins to shift. From January, eurozone borrowers will have to contend with the ECB cutting its bond buying programme in half to €30bn a month. It has said it will maintain that until at least September.
But the ECB’s move has caused little concern for borrowers that snapped up euro funding last year.
“We raised more than 60% of our funding last year in euros,” says Rentenbank’s Olma. “I don’t know if we have ever had such a high issuance volume in euros. Normally the dollar is our most important currency. The reason for that is pretty clear — it has been driven by the ECB’s purchasing programme. It was a great year for us because it allowed us to raise duration.
“This year’s funding plans should be similar to last year’s. The ECB is of course scaling down its purchase power, but nevertheless it will continue to buy so I don’t see big changes coming up. We might end up in a similar situation to last year. The euro issuance may not be as high but it will be close.”
While there is confidence that the ECB’s shopping spree should help keep the euro market buoyant, it may well be that issuers looking for length in that currency do so early in the year.
“The obvious question is around the long end,” says Jamie Stirling, global head of supranational, sovereign and agency debt capital markets at BNP Paribas in London. “So far the ECB’s communication has been well signalled; there hasn’t been much market reaction and little volatility around it.
“But should issuers be raising duration at the beginning of the year, given tapering concerns that could lead to a steeper curve and waning long end demand? While we think that duration should be accessed when feasible, we do not necessarily feel that the trend of ultra-long demand or supply will disappear, despite the risk of higher yields.”
But borrowers should be cautious of being too optimistic, says Sean Taor, head of European DCM at RBC Capital Markets in London.
“Market participants are more relaxed going into 2018 than they were last year, when the political landscape was causing a lot of concern that, with hindsight, was unfounded, because over 2017 the markets were very supportive,” he says. “Spreads have performed and investor demand has remained very strong.
“This year, with QE running at least until September, issuers will be more relaxed, but I would caution against that. I wouldn’t take the status quo for granted — it’s not a new normality. Going back 10 years, average eurozone government yields were 4% and now they are 1.5%. That’s not driven by anything other than QE.
“The average norm is 2.5 percentage points higher than where we are. If QE unravelled, we would potentially see even higher than that.”
Back in play
Any change in the currency balance of SSA funding resulting from a shift in the long end from euros to dollars could be tempered by opportunities opening up at the short end in euros — further alleviating the congested three to five year dollar market.
The ECB’s QE cut may help support yields in the short end, bringing that sector back into play for borrowers that have been able to offer only a negative rate in that area. That will be contingent on the central bank’s messaging not disturbing markets, however.
“The ECB has the benefit of having some market precedent in seeing what happened at the end of QE in the US and UK,” says Lee Cumbes, head of SSA DCM at Barclays in London.
“The other consideration is that inflation, while apparently not at risk of deflation, is still reasonably low versus target. Projections are that it may even move lower in the early part of 2018. Therefore, this is not only about managing markets, but data dependency too and keeping options on the table to see how the macro picture develops.
“For markets, I think the main fear would more be of an unstable or disorderly sell-off, that does keep investors away until they have a clearer direction on the market. But a moderate repricing of yields may unlock some sources of demand that either have been pushed to the sidelines or moved to different asset sectors temporarily.
“There are traditional areas of demand that have been displaced by central bank buying.”
All of this will be tempered by moves in the euro/dollar cross-currency basis swap. Issuers with dollar needs, particularly at the short end, say they monitor the euro market constantly — but that swapping back into dollars is still prohibitively expensive.
If central bank actions do lead to spread widening in the SSA market, it could have one additional unintended — but perhaps welcome — consequence.
Some green bond issuers, such as the European Investment Bank, say they are starting to see a separate green bond curve develop, inside their conventional issuance. Others add that although they may not have a green curve, they are usually able to print green bonds with a lower new issue premium than a conventional issue would have required.
With more borrowers bringing ever more SRI paper, but still not nearly enough to meet the demand of green investors, which typically buy and hold, the difference between green and conventional spreads is expected to widen.
“There is a basis developing between green and classic bonds,” says Stirling. “Two years ago, investors were not willing to relent on spread, but the additional value of the sustainable segregation of assets is now fiscally recognised. Green or social bonds now trade a couple of basis points tighter.”
Limiting issue sizes will also probably add to the trend.
“It’s true that green bonds tend to be smaller issues, but the level of demand is also picking up and has often outstripped the level of supply,” says Cumbes.
“The use of no-grow language on deals of any size has also created an extra level of competition recently. That language can be more common on green bonds because of the limited specific assets available.
“Therefore, these issues have been priced through conventional bonds — and as this supply to demand dynamic is maintained, this will become more of an established pattern.”