Sterling SSA primary market dynamics in 2016
The sterling SSA primary bond market is set to have a record breaking first quarter in terms of issuance volumes, which currently stand at £12.25bn. There have been a number of notable deals from inaugural issuers and those returning to the market after a long break, but also regular issuers have achieved much bigger volumes. From the demand side, the breadth of participation has also been apparent, with the three big investor bases — central banks, bank treasuries and UK real money — all participating in good size. We look into the reasons why and whether it will continue.
Primary market record volumes — why?
There are a number of reasons for such a strong Q1 in the sterling SSA primary market. Looking at the broader backdrop, the monetary policy stance and the market’s expectations shifted in Q4 2015 which meant demand was very strong. Put simply, the BoE’s first rate hike was re-priced by the market from mid-2016 to early 2017. First to react was the FX market followed by a rally in short sterling futures, but it was not until January that we started seeing a much larger bid for sterling fixed income emerge.
However, without much supply at the end of 2015, there was no obvious effect on the SSA market and spreads remained stable. Once issuance began in January, we immediately began to see the knock-on effects. Investors used the supply to position for the rally in yields and international investors could utilise the weaker currency too. This is also highlighted by the fact Gilts have had a total return of circa 4% year to date, one of the best first quarters on record for the market.
Looking more closely at the sterling SSA market dynamics and given the macroeconomic backdrop, the market presented a very good entry level for investors. Spreads to both Gilts and 3m sterling Libor were at the multi-year wides following the turbulent markets in Q3 which had an impact on all spread products and risk sentiment globally.
The technical backdrop was also very supportive coming into January 2016. Supply was relatively limited in Q3 and Q4 and there were very large December 2015 redemptions, totalling circa £12bn (excluding any maturing Gilts).
Finally from the issuers’ point of view, either euro or dollar based, the pricing has been attractive. This has been driven by moves in the cross-currency basis swap market but also the wider dollar spreads which are used by issuers for comparisons.
Sterling SSA demand profile
The demand profile in new deals has been significantly stronger than in previous years. Deals have had a broad base of support and are not over-reliant on one group of investors which may have been the case in the past.
This point is also highlighted by a change in the European Investment Bank’s issuing pattern where fixed rate issuance accounts for 90% of the EIB’s £3.2bn of supply in 2016, compared to just 26% in the same period in 2015 and 30% in 2014.
While bank treasuries remain an important investor group, their share of demand has decreased. However, it’s also worth noting that since a change in the BoE/PRA liquidity rules, there’s anecdotal evidence that the smaller domestic ‘challenger banks’ have expanded their list of names they are looking to buy for LCR purposes.
As the bank treasuries are a smaller percentage of deals, the return of large orders from the UK real money community has more than made up the difference. It is a welcome development and is a contributing factor to larger deal sizes. Clearly when spreads versus Gilts moved wider it was a question on everyone’s mind as to when the UK accounts would step in and buy.
Outlook and risks
Clearly the largest risk for the sterling SSA market and the sterling market as a whole is the June 23 referendum on Britain’s membership of the EU. There is a lot of speculation about what an exit from the EU could mean for the UK, for markets and for monetary policy. The fact is we do not know what an exit would look like and predicting the pattern of events is difficult.
Simply looking at the sterling SSA market, last year’s general election and the Scottish independence referendum in 2014 which — were both close in the polls — gives us an indication of how the market might deal with the uncertainty. Sterling SSA primary deals were still well supported in the run up to these events and following them there was a relief rally in Gilts where the removal of the risk event provided support for fixed income.
Changes in the structure of the market
There has been a number of banks reassessing their dedication to euro sovereign trading businesses and with that, Credit Suisse and Société Générale both recently relinquished their GEMM responsibilities. However TD Securities’ increasing presence in the sterling SSA market is an example of the changes that we are witnessing in the supra and agency market. The concept of a traditional ‘sterling bank’ has long gone as the investor base is far more internationalised than in the past. Additional factors such as swap capability and balance sheet commitment are also increasingly important for clients.
As issuers look around the globe for arbitrage funding it is essential for banks to have a presence in as many of those markets as possible to offer issuers and investors a full service. The importance of this strategy was highlighted in January where the sterling market was hot but some emerging market currencies were not. As there are now fewer avenues to provide issuers with arbitrage we expect more competition between banks for sterling business.
In conclusion, the very strong start to the year may not continue at the same pace given the event risk ahead, but there are a number of the same factors still in place. Combined with recent central bank dovishness this gives a promising outlook for the sterling SSA primary market.
Author:Mark Byrne, Fixed Income Origination & Syndication, TD Securities