Corporate Treasury Weekly: credit markets normalise as inflation creeps into more discussions

27 May 2021

Giles GaleHead of European Rates Strategy

View bio

Other insights

View more insights

3 minutes 

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

Credit markets are starting to normalise as expectations of higher inflation feed through to bond yields and swap prices (which are both rising), but we don’t see this as especially concerning. Investors are becoming more selective, but they also have cash to deploy and the need to deploy it. At the same time, we see inflation increasingly creeping into an array of discussions.

  • US bond yields are still the frontrunner among broadly higher global rates: Comments made last week by US Federal Reserve Vice-Chair Richard Clarida suggest – at least to us – a greater appreciation of rising inflation expectations and slightly less dovishness than markets seem to believe. We still think the Fed will use the September meeting to signal its intentions to reduce quantitative easing or QE (starting in 2022), employment & inflation data permitting. But if the next inflation data is firm, it may be possible that this is accelerated, which means higher bond yields sooner than expected as investors look to get ahead of the shift.
  • The European Central Bank (ECB) looks less likely to taper QE in June: Rising US yields may put upward pressure on global rates, but in the Euro Area, the ECB now looks less likely to reduce its rate of QE than we thought just weeks ago – partly due to a rise in yields, and the risk of fragmented financial conditions. We suspect there may be pent up demand for bonds into the summer, especially if the ECB maintains its current QE policy.
  • Drags on inflation – like tepid wage inflation & stronger Pound – may keep UK yields in check near-term: Although the UK economic recovery is gathering pace, which is positive for growth and puts upward pressure on yields, underlying wage inflation remains tepid – even as employers struggle to fill vacancies. A stronger Pound could also be a moderate drag on inflation. In the short term, there remains huge uncertainty around monthly inflation readings throughout the summer as spending on pandemic-affected items (energy, travel, clothing) continues to normalise.
  • Bitcoin’s recent volatility doesn’t mean credit & equity valuations will come under pressure: Bitcoin was significantly more volatile last week (even by cryptocurrency standards), but despite its 35% fall we don’t anticipate any contagion to other markets. Bitcoin’s positive association with stock prices is largely spurious and mostly due to the fact that both have been rising.
  • Stronger growth is positive for commodity-linked currencies but negative for the US dollar: The stronger global growth outlook and the positive backdrop for risk assets is driving FX, which means a weaker US dollar and stronger commodity-linked currencies (think Aussie Dollar, Canadian Dollar). We also think lower levels of uncertainty in the broader UK economic outlook – perhaps the lowest levels in quite a long time – is positive for the Pound.

Inflation creeps into more discussions

Inflation is clearly a talking point for many, creeping its way into a broadening array of discussions and in slightly different ways across geographies. From a fundamental perspective, European firms are often concerned about cost pressure (via inputs but also finance) on margins due to limited pricing power, especially where tied into long-term contracts. But UK firms, on the other hand, have been more focused on how to protect themselves from a strengthening Pound.

Bond spreads are widening as investors get more selective

We are seeing some credit spread widening and new issue premia for some bond issuers as expectations build around greater inflation pressure and higher rates. We also see investors becoming more selective, and with many corporates sharing the same underlying concerns as their financiers (rising rates, higher inflation) some firms are starting to accelerate their fundraising plans. Overall, we think spread widening will be limited as investors have cash to deploy – and the need to deploy it – and we see this as part of a broader normalisation of credit markets.

The latest Bank of England (BOE) Credit Conditions Survey, which helps paint a picture of why corporates are borrowing, lends some weight to the view that a rise in capex waits in the wings. The latest reading shows a pick-up in funding for acquisition purposes, already at multi-decade highs, alongside a very sharp rise in borrowing to fund capex – the highest levels seen since 2014.

UK corporate borrowing: capex vs. M&A

Sources: Bank of England, NatWest Markets

For the full weekly newsletter login to Agile Markets. Don’t have access? Contact us here.

CORPORATE TREASURY


This document has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes.  It is indicative only and is not binding. Other than as indicated, this document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this document, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this document. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and any issues that are of concern to you.

This document does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.

NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, the Netherlands. Branch Reg No. in England BR001029. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (http://www.finra.org), a SIPC member (www.sipc.org) and a wholly owned indirect subsidiary of NatWest Markets Plc. Copyright 2021 © NatWest Markets Plc. All rights reserved.