The bull market is real, but issuers must stay balanced on pricing
Issuers should take advantage of the favourable funding conditions — but keep offering concessions as they do
Less than a month into the new year, bond markets are in rude health. What investor sentiment and relative value performances show is that borrowers can — and should — take advantage of these market conditions.
Data across multiple segments of bond markets screams of a trend not so different of a bull market. As the old market adage goes, the trend is your friend.
Issuance records have been crunched across supranational, sovereign and agency, financial institutions and emerging markets. There are no signs of the vigorous issuance machine stopping just yet, but borrowers should hurry and make haste while it works.
As of January 20, the €190bn bond issuance volume in euros, excluding government auctions and asset-backed securities, had smashed its record for a fourth year in a row. Moreover, the market is on track to break this month the €200bn barrier for the first time, GlobalCapital’s Primary Market Monitor (PMM) revealed this week.
What's more, volumes are not a deceiving signal of the market conditions. In fact, underlying demand is clearly driving the supply.
Not only have subscriptions ratios been consistent across SSA, FIG and corporate markets, as PMM shows, but they have gone up for financial institutions. Coverage ratios for FIG deals increased for both unsecured and covered bonds, helping borrowers pay lower new issue concessions.
The average FIG benchmark bond offered 16.3bp of new issue premium in the first week of January. That had fallen to 9.8bp by last week, according to PMM. This kind is no doubt an enticing factor for issuers.
The great return
Bond bankers, across ranks and functions, have referred to this investor zeal to buy bonds as a fear of missing out the rally in credit markets. Accounts are eager to book in the higher rates, before the Fed, or even the European Central Bank, embark on a likely policy pivot.
The desire to lock in better entry points has driven a massive outperformance. Euro investment grade bonds have produced a 2.18% total return year-to-date, as of January 20, while sterling IG has done even better: up 3.58%, according to CreditSights. High yielding bonds in euros and sterling have returned 2.86% and 3.11%, respectively.
No wonder investors are obsessed. After all, last year was arguably the worst ever for bond markets in the modern world of finance.
Looking back at past year’s performance. Euro IG bonds lost about 11.5% over the past full year while sterling IG was down 15.4%, CreditSights calculations showed.
But it’s even more painful to look across the vast world of financial assets of any kind. In US dollar terms, after a massive spike in the currency, only Brent, WTI oil and silver produced any gains for 2022, according to Deutsche Bank research. Some of the worst performing assets were Gilts and the Nasdaq, each losing around 33%.
Investors are therefore more than eager to make up some of the lost ground in both relative and absolute terms.
Ahead of the reckoning
The start of the new year has reset performance versus benchmarks and new funds have poured in, leaving investors eager to show blockbuster returns.
They may be able to do so, at least for now. What looks, feels and sounds like a bull market probably is very much a bull market.
Even the struggling covered bond market appeared to turn a page this week.
On Monday, Deutsche Kreditbank restarted long end public covered bond issuance beyond 10 years that has been closed since June last year. All this while €6.8bn of public secured paper was sold and well absorbed in just two days, prompting one FIG syndicate manager in Germany to call this a “little renaissance” in covered bonds.
Despite the deluge of supply, bank credit spreads have barely budged or even slightly tightened compared to where they started the year.
The iBoxx € Banks Senior Index ended 2.8bp tighter on Monday even after €5bn was issued in covered and senior bonds, reaching 98bp, a level 1bp below where the index started off 2023.
In comparison, the covered bond equivalent index remained virtually unchanged and had recorded just a 1bp widening since the start of the year. All this after issuers have increased their spreads and new issue concessions in the asset class.
Thus the FIG market in Europe has demonstrated that it works well, and it's been a similar story in corporate issuance — where subordinated deals have done especially well. Iberdrola, EDP and the most recent hybrid on Tuesday from Red Electrica have all received huge orders.
These are overwhelming indicators of hungry, cash-rich investors eager to buy bonds.
If it ain't broke
In the face of such deep demand, it might be tempting for issuers to get aggressive. But they should continue to replicate the formulas that have proven to work so far.
First of all, time is of essence. As GlobalCapital opined last week, negative real rates and the borrowing binge could yet end this issuance party. Inflation has not yet peaked in Europe, and the ECB’s quantitative tightening is yet to begin. These factors will hurt bond performance.
There is also another worrying signal across the Atlantic. In the US, the Conference Board Leading Economic Index for December, released on January 23, reached 110.5. This is signalling a looming US recession, according to the Conference Board.
Borrowers should therefore continue to feed investors with what they want: not tightly priced bonds, but deals that offer some concessions. The future may be precarious, but this should entice investors to keep buying and enable issuers to move ahead with their funding — for now at least.