Corporate Treasury Weekly: can bond yields go even lower?

12 August 2021

Giles GaleHead of European Rates Strategy

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Breaking down trending trades & themes to help corporate treasurers get ahead of the latest issues shaping markets.

Bond yields are resuming their upward move as the Bank of England and the Fed look set to tighten monetary policy, but after an unexpected rally in July, treasurers are diverging on how to treat rates – and questioning whether they could fall further than they (or the market) could imagine.

  • The Bank of England’s (BoE) approach to withdrawing monetary policy support could lead to a steeper yield curve. The BoE largely delivered what markets expected last week, but early details of its strategy for tightening monetary policy piqued our interest. The Bank plans to sell gilts held once the policy rate reaches 1%. This strategy appears to suggest that as rates rise, the UK yield curve may steepen. Although 1% is a distant target today (at the time I write this, no gilt yields 1%) markets will factor this thinking in continuously if rates rise.
  • The Fed is on course to taper quantitative easing (QE) later this year. The vice Chair of the Fed, Richard Clarida, made a speech last week that deserves attention. He pointed out his expectations for inflation and employment would justify rate hikes by the end of 2022, and that if inflation exceeds 3% this year (as we expect it to) it would be higher than justified by its current inflation targeting regime. Meanwhile, the Atlanta Fed Chair, Raphael Bostic, said this week he expects rate hikes to be justified next year. If that timeframe is to be achieved, QE tapering needs to begin soon – possibly next month, which means higher yields.
  • Markets still fear China’s brush with the Delta variant, while Europe may have passed the peak of the latest wave. China’s “zero-COVID” policy in tackling the Delta variant may further weigh on Q3 growth momentum and invite easier monetary policy to help support the most affected sectors. On the other hand, European infections may have peaked – helped by the warm weather and strong vaccination progress.
  • Bond yields are rising, reversing some of the falls seen last month, but credit remains strong. A more hawkish Fed, strong labour market data (943k jobs added in July), and a sense that Delta fears may be overblown has US bond yields rising again after falling last month. But we don’t see rates rising too quickly until September, when a busy period of central bank meetings awaits. Still, credit appears well-positioned (more on this later). Stocks at all-time highs may have difficulties if economic growth slows, and rates may struggle if it doesn’t – but credit can do well in both cases.
  • We’re neutral on the US dollar and feeling good about Sterling against Euro in the near term. Rate hikes are now well within the forecasting horizon and the US dollar is no longer an attractive funding currency for global investors. We also see Sterling performing well against the Euro, at least in the short term; monetary policy in both jurisdictions is diverging, with UK heading in a more hawkish direction.

Can low rates go lower?

Treasurers we speak with have been very interested in discussing the high levels seen in almost all markets. Views on rates have varied. While most agree that rates are low (more so last week, of course), the discussion of the opportunity this presents is coloured by recent experience where rates have shown that they can fall much further than imagined. As ever, with chronically low rates, cash management is an issue. Some are investigating solutions like ‘forward’ bonds, which allow issuers to defer proceeds to help address that challenge.

The autumn window in primary bond markets opens in earnest in a couple of weeks

We expect Euro primary bond markets to open the week of August 23 and Sterling markets the week after due to the bank holiday. We don’t expect the market to be as active as it was in 2020, largely because corporate liquidity positions are comparatively much more comfortable, but we expect M&A activity – which was relatively strong in H1 – to drive bond issuance in the second half of the year. For more on the credit outlook and key risks to look out for, check out our Q3 outlook.

Bond supply in Europe has all but ground to a halt in July, which certainly complicates positioning for investors after a strange July but makes for a very supportive market for issuers. Supply in the middle part of August approaches zero for non-government issuers, and only a few billion for government issuers (of which Germany accounts for €4 billion).

European primary bond issuers are out of office (issuance in € billions)

Sources: Bondradar, NatWest Markets

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