The EU’s impending €14bn Support to mitigate Unemployment Risks in an Emergency (SURE) transaction, scheduled for syndication on Tuesday, is expected to help set the tone for secondary markets, which have been under pressure most of this month.
Hedge funds and market makers have driven the recent selling pressure in anticipation of the new issue amid concerns about higher inflation and slackening central bank asset purchases.
Though one trader thought the SURE bond could offer an initial concession of 25bp, a second described this as nonsense, saying it would be “good way [for the EU] to destroy their curve”.
"My personal take is that the market has widened a lot and clients are now looking to re-enter," said the second dealer. "It still feels a bit nervous, but if [the EU] start 15bp wider, then I expect they’ll be able to tighten to a more reasonable spread… but you never know”.
He noted that some “fast money” accounts had shorted the EU’s 2046s on anticipation of a tap, only to find that the borrower was set to issue two new deals, thereby causing a modest short squeeze in the bonds.
Selling pressure had been notable in all major EU government bond markets but especially in OATs, which have widened by about 10bp in the 10 year sector over past week and a half versus Bunds.
“People are looking forward and thinking about the possibility of European Central Bank tapering asset purchases, which means a higher, steeper rates curve,” said another trader. “But the main take away so far is that secondary flows have not been enormous, they’ve been dealer-led.”
He went on to describe Tuesday’s EU deal as “a litmus test,” agreeing with the first dealer that spreads had come a long way as a result of market maker hedging activity and hedge fund shorts being stopped out.
Covered conundrum
United Overseas Bank, Raiffeisen-Landesbank Steiermark and Landesbank Saar have all mandated leads for covered bonds that could be launched on Tuesday even though rates markets are widening.
One dealer questioned the wisdom of issuing covered bonds in this market. He pointed to the fact that the State of Lower Saxony had been in the process of selling a €500m seven year on Monday with a 3bp new issue concession. The absence of a timely order book update led him to conclude that demand for the deal had been anaemic.
Recently issued covered bonds from the Royal Bank of Canada, Canadian Imperial Bank of Commerce and Compagnie to Financement Foncier were all bid 1.5bp wider on Monday compared to a week before, along with most of the rest of the market.
Though this was not a large move, it was important because it was the first time this year that covered bonds had widened.
Despite the lack of real money investor activity, the same trader did not doubt there was a real sense of caution driven by the prospect that market makers could encounter difficulty selling paper to the ECB — a trade which had largely driven the secondary market tightening in covered bonds so far this year.
But not everyone thought that the ECB was about to upset the market at its meeting on June 10. “I doubt we’ll see dangerous talk from Lagarde, she’s learnt from her previous mistakes,” said the first trader.
Even though the economy is expected to improve, there is still confidence that the ECB will do all it can to prevent a tightening of financial conditions. “They will tolerate higher yields but not aggressively tighter," said the trader, "and bear in mind a lot has already been discounted, the market always overreacts.”